Wednesday, March 30, 2016

FDI Reforms in E-Commerce: What Do They Entail?

In a post on this Blog earlier this month, Satyajit Gupta and Saurabh Sharma elaborately discussed the background to the foreign direct investment (FDI) policy in the e-commerce sector. Ambiguities in the policy have not only given rise to uncertainties to players in the sector, but have also resulted in multiple rounds of litigation. As they demonstrate, the dominant e-tailers have gravitated towards the “marketplace” model of e-commerce, in some ways by taking advantage of the ambiguities in the policy. Yesterday, the Government issued Press Note No. 3 (2016 Series), which clarifies the position on FDI in e-commerce, and legitimizes the marketplace model, but with some significant riders. The purpose of this post is to examine this important FDI reform with a view to determining the extent of impact it may have on the e-commerce sector.

Pre-existing Position

Under the FDI Policy Circular, FDI has permitted up to 100% in e-commerce activities. Importantly though, this covered only B2B trading and not retail trading (i.e. B2C). B2C trading was permitted through limited ways such as where (i) a manufacturer of products in India could sell online, and (ii) a single brand retail entity could sell products online as a means of supplementing its brick and mortar sales. However, pure-play B2C trading activities were out of bounds.

In order to overcome these restrictions, as Satyajit and Saurabh point out, various e-commerce companies began carrying out retail trading through the marketplace model whereby the companies would only provide a technology platform to enable trades to take place between various sellers and purchasers of goods. One may consider this to be a form of regulatory arbitrage. Although investigated by the authorities and challenged in courts, there was nothing unequivocal to indicate the illegality of the model.

It is in this milieu that the Government yesterday issued Press Note 3 to clarify the regulatory position regarding FDI in B2C e-commerce. The current uncertainty has been put to an end, as the Government has declared the marketplace model to be an acceptable one so long as it has been accompanied by compliance with certain stringent conditions the Government has prescribed.

Nature of the Reforms

The principal effort of Press Note 3 is to define e-commerce and to bifurcate it in to the (i) marketplace model and (ii) inventory based model. It then goes on, from an FDI perspective, to conditionally embrace the former while conclusively shunning the latter.

The press note defines marketplace model as one that provides “an information technology platform by an e-commerce entity on a digital & electronic network to act as a facilitator between a buyer and a seller”. It also defines the inventory based model as one “where inventory of goods and services is owned by e-commerce entity and is sold to the consumers directly”. While 100% FDI under the automatic route is permissible under marketplace model, FDI is prohibited under the inventory based model: two diametrically opposing results depending upon which model is chosen.

More importantly, the liberal FDI in the marketplace model is subject to several conditions. It would be helpful to touch upon some of those. E-commerce entities are entitled to provide support services to sellers. However, the policy clearly prevents them from taking on ownership over the goods sold. If they do so, they will be treated instead as an inventory based model (which will cause them to be in breach of the FDI policy).

A condition that has attracted some level of controversy relates to that fact that no more than 25% of an e-commerce entity’s sales can relate to one vendor or its group of companies. Evidently, this is an anti-abuse provision, in order to ensure that the true nature of the marketplace model is preserved, and that an inventory based activity is not carried on in the garb of a marketplace. This would prevent entities from creating marketplaces that are effectively extensions or outsourced vehicles of trading arms. This would call into question some of the currently marketplace structures, which operate as platforms for group entities that effect the sales of the goods.

Consistent with the marketplace model, the responsibility for sales, after-sales services and customer satisfaction will lie with the sellers, and cannot be assumed by the e-commerce entity. Similarly, any warranties or guarantees relating to the product are only the responsibility of the sellers.

Another condition that has invoked a great deal of discussion relates to pricing and discounts, which would now lie only with the sellers of the goods. The policy is explicit in stating that the e-commerce entities “will not directly or indirectly influence the sale price of goods or services and shall maintain level playing field”. This is ostensibly with a view to ending the discount wars that are prevailing between various e-tailers and which enable them to compete more effectively with brick and mortar traders. In other words, the marketplace model is a true reflection of the fact that the e-commerce entity provides nothing but the platform, and can in no way influence or intervene in the commercial terms of the transaction, which is purely a matter between the seller and the buyers of the goods. While the underlying concern behind this seems to be to protect small businesses and brick and mortar stores against discounted products offered online, it remains to be seen how this condition can be implemented. How does one determine “influence”, whether direct or indirect that the e-commerce entity can exercise over the sellers? Much would be left to the discretion of the regulators, which may therefore leave some uncertainty in the process.

Conclusion

The Press Note is welcome in that it clarifies the position regarding FDI in e-commerce, which has been shrouded in uncertainty until now. It is likely to reduce any possibility of regulatory arbitrage that has been rampant in the sector. Activities in the form of the marketplace model that were being carried out under the prevailing uncertain regime have now been legitimized with conditions. While some of the existing players may now have to reorient their affairs to meet with this more onerous conditional regime, it may open up the space for other players and investors who have been waiting in the wings for a clearer regulatory regime.

The policy has received opposing reactions with equal strength. On the one hand, some believe that the heavy conditionalities accompanying the marketplace model make it virtually unviable. Others believe that the opening up of the e-commerce sector itself poses a threat to domestic brick and mortar businesses. This is not surprising given that FDI in the retail sector has been an emotive issue for a number of years. While the earlier debates were largely steeped in the perceived threat of large shopping chains owning mega stores across the country, this round has been focused on sales through electronic means. Apart from a variation in the mechanics of how the browsing and shopping takes place, the real issues and controversies are rather similar. Given the polemic nature of the issue, the debates are likely to continue, as are the legal challenges before courts.

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