Wednesday, June 17, 2015

Lack of Regulatory Clarity on Foreign Investment in the Insurance Sector

[The following guest post is contributed by Nivedita Shankar, Senior Associate, Corporate Law Division, Vinod Kothari & Company. The author may be reached at nivedita@vinodkothari.com].

An increase in the threshold limit for foreign investment in insurance companies has been hailed as a major thrust for the insurance sector, which has seen very few players. In this background, the Indian Insurance Companies (Foreign Investment) Rules, 2015 (‘Rules, 2015’) were issued by way of Notification No. G.S.R. 115(E) dated February 19, 2015 with the intention of providing regulatory clarity on shareholding pattern in Indian insurance companies. However, Rule 4 of Rules, 2015 has posed a vital question for Indian insurance companies – how to ensure compliance with Rules, 2015? As has been discussed further in this post, the very intent behind issuance of Rules, 2015 was to ensure that Indian insurance companies are always owned and controlled by resident Indian citizens. In fact, the Insurance Laws (Amendment) Act, 2015 also amended the definition of Indian insurance company to allow only 49% of foreign investment, which meant that the rest of the shareholding was to be with Indians. However Rule 4 of Rules, 2015 has played a complete dampener in this regard. Where the idea pursuant to amendment of FDI Policy and Insurance Laws (Amendment) Act, 2015 is clear that Indian insurance companies have to be under the control of resident citizens, Rule 4 of Rules, 2015 is creating an additional requirement by requiring Indian insurance companies to look one layer up and see the actual ownership and control behind the resident Indian citizen.

Provisions of Rules, 2015

Rule 3 of Rules, 2015 states that:

No Indian insurance company shall allow the aggregate holdings by way of Total Foreign Investment in equity shares held by Foreign Investors, including portfolio investors, to exceed forty-nine percent, of the paid up equity capital of such Indian insurance company.

Rule 4 of Rules, 2015 states that:

An Indian Insurance Company shall ensure that its ownership and control shall remain at all times in the hands of the resident Indian entities referred to in clauses (k) and (l) of rule 2.

To juxtapose the two Rules stated above, where on one hand Rule 3 allows total foreign investment to the tune of 49% of the paid up equity capital of Indian insurance companies, Rule 4 on the other hand prescribes that only Indian resident citizens can control and own the Indian insurance companies. Looking at the definition of ‘Indian Ownership of an Indian Insurance Company’[1] and ‘Indian Control of an Indian Insurance Company’[2] in Rules, 2015 what transpires is that even if foreign investment is capped at 49%, the rest of the investment has to be in the hands of resident Indian citizens which basically means that they have to be owned by Indians. Hence, where on one hand foreign investment is not allowed beyond 49%, on the other hand ownership and control is allowed by only such companies that are owned by Indians. This rules out the possibility of Indian insurance companies being owned and controlled by such companies that may have been incorporated in India but are ultimately foreign controlled. Hence Rule 4 prescribes a requirement that is beyond what was actually envisaged.

Further, similar to the Consolidated FDI Policy, the Insurance Regulatory and Development Authority of India (‘IRDA’) has also prescribed the method for calculating the direct and indirect investment in Indian insurance companies. Since by virtue of para 4.1.4 of Consolidated FDI Policy, insurance companies are not subject to calculation of direct and indirect foreign investment as prescribed therein, one has to refer to IRDA (Registration of Indian Insurance Companies) (Seventh Amendment) Regulations, 2000 (the ‘Regulations 2000’) which is yet to be published in the Official Gazette. Regulation 11 prescribes the method for calculation of direct and indirect holding of equity capital held by foreign investors as follows:

1. the  quantum  of  paid  up  equity  share  capital  held  by  the  foreign investors including foreign venture capital investors, in the applicant company; and

2. the proportion of the paid up equity share capital held or controlled by such foreign investors in the Indian promoters or Indian Investors as mentioned in sub- clauses (i) of this sub regulation.

Reading Rule 4 of Rules, 2015 and 7th Amendment to Regulations, 2000, the following two scenarios can be envisaged:


Exhibit 1




Exhibit 2

Analysis

We now analyse the effect of Exhibit 1 and Exhibit 2 in light of Rule 4 of Rules, 2014:

If the Indian Company D is owned and controlled by resident Indian citizens
If the Indian Company D is incorporated in India but not owned and controlled by resident Indian citizens
Evidently from Exhibit 1 it is clear that more than 50% of the total paid up capital of Indian insurance company is held by Indian resident citizen. Hence compliance with Rule 4 is not an issue. Also, since the non-resident body corporate is holding less than 49%, provisions of Rule 3 are also met.
This is a case of Foreign Owned and Controlled Companies (‘FOCC’) which are subject to the provisions of Consolidated FDI Policy, 2015. Going by the definition of Foreign Investors[3] in Rules, 2015, it is clear that FOCCs do not qualify to be Foreign Investor.

Hence owing to the fact that any FOCC is not owned and controlled by resident Indian citizen, for the purpose of Rule 4 of Rules, 2015, any FOCC cannot invest more than 49% in the Indian insurance company. Hence what will constitute 49% is holding of Foreign Investors + FOCC.

This leaves Indian insurance company in a very peculiar position. This is because the rest of 51% will have to be mandatorily held by resident Indian citizens only. Hence Indian insurance company having a structure similar to Exhibit 2 will have to rethink their shareholding pattern.


Thus there is an obvious disconnect in the way Rule 4 has been drafted. The intent was of course to ensure that insurance companies in India are owned and controlled by Indians. However this has led to Rule 4 being drafted in such a way that it unintentionally imposes additional compliance burden for Indian insurance companies. The way Rule 4 has been drafted, it also hints at lack of regulatory clarity on what should be the actual shareholding pattern of Indian insurance companies. Thus even if it is clear that foreign investment cannot be more than 49%, clarity regarding Indian investment is also required at the earliest.

- Nivedita Shankar





[1] Indian Ownership of an Indian Insurance Company means more than 50 per cent of the equity capital in it is beneficially owned by resident Indian citizens or Indian companies, which are owned and controlled by resident Indian citizens.       
[2] Indian Control of an Indian Insurance Company means control of such Indian Insurance Company by resident Indian citizens or Indian companies, which are owned and controlled by resident Indian citizens.
[3] Foreign Investors for the purpose of Rules, 2015 means all eligible non-resident entities or persons resident outside India investing in the equity shares of an Indian Insurance Company, as permitted to do so through Foreign Direct Investment and Foreign Portfolio Investment under FEMA Regulations, 2000 as described in these rules.

3 comments:

vswami said...


Sporadic (to share tentative reaction)
As independently understood, the premise on which the rules have been framed and founded on the latest innovative thinking that ‘equity shareholding’ and ‘controlling interest’ are two distinct , not connected or related, concepts; and are not but mutually unrelated and has to be forcibly divorced. Except that, each empowered authority has chosen to frame its own Rules but differently; and that seems to account for the fact that the rules under reference are mutually conflicting, hence confusing lending no clarity.
Is this not nothing but yet another development that juts out and bears testimony to the irreversible perpetuation, and unmindful extension , - that all started in the field of tax regime- of that very same idea,- rather than an obsession haunting/troubling the brains behind since then,- of unduly placing over-emphasis on preference to “SUBSTANCE “ over “ the "FORM”?!
Open, as ever before remain, to be enlightened!


Anonymous said...

The analysis presented for Exhibit 2 is completely wrong and misguiding. Regulation 11 states that

“1. the quantum of paid up equity share capital held by the foreign investors including foreign venture capital investors, in the applicant company; and

2. the proportion of the paid up equity share capital held or controlled by such foreign investors in the Indian promoters or Indian Investors as mentioned in sub- clauses (i) of this sub regulation.”

Only in the event that such foreign investor (the same entity investing in Point 1) holds shares in the Indian Party and if the total shareholding of such foreign investor exceeds 51% in the Indian Promoter/Indian Investor will such Indian Promoter/Investor stand in violation of Rule 4 of Indian Insurance Companies (Foreign Investment) Rules, 2015 by not being an IOCC and hence be ineligible to invest in the applicant insurance company.

Request the editors to review guest posts. This blog is well reputed and such callous analysis is unworthy of publication herein.

Nivedita Shankar said...

Sir,
The very intent behind giving Exhibit 2 was to show the anamoly of Rule 4. It is further explained in the Table below.Any FOCC is a company in which non-resident entities hold more than 50%.