Foreign Investment in Securities – A Boon or a Bane?
December 19, 2021
Foreign investment involves capital flows from one country to another, granting the foreign investors extensive ownership stakes in domestic companies and assets. Foreign investment denotes that foreigners have an active role in management as a part of their investment or an equity stake large enough to enable the foreign investor to influence business strategy. It is seen as a future driver for economic growth and can be done by individuals, although it is mostly pursued by giant companies and corporations with significant assets planning to expand their reach.
As a result of globalization, an increasing number of businesses are establishing their branches all over the world. Opening new manufacturing and production units in a different country have benefited certain multinational corporations due to lower production and labor expenses. Large firms also seek to do business with nations that have the lowest tax rates, which they do by shifting their headquarters or sections of their operations to a country that is a tax haven or has tax regulations that are favorable to foreign investors.
Types of Investment
There are two types of foreign investments: direct and indirect. Foreign Direct Investments, or FDIs, are physical investments and purchases made by a corporation in a foreign country, such as the establishment of plants and the purchase of buildings, types of machinery, factories, and other equipment. These investments are more popular because they are considered long-term investments that help strengthen the economy of the foreign country. On the other hand, corporations, financial institutions, and individual investors purchase interests or positions in international enterprises listed on a foreign stock exchange. It is deemed less favorable because a domestic corporation can simply sell off their investment very fast, even within days of purchasing, depending on their whims and fancies. These indirect investments, often known as Foreign Portfolio Investment (FPI), involve both equity and debt instruments such as stocks and bonds.
Advantages of Foreign Investment
FDI may help a target country’s economy grow by creating a more suitable environment for businesses and investors, as well as stimulating the local community and economy. Import tariffs are normally imposed by each country, making trade difficult. To guarantee sales and goals are reached, several economic sectors demand a presence in overseas marketplaces. All of these facets of international trade are made much easier by FDI. As investors establish new businesses in foreign countries, FDI creates new jobs and possibilities. This can result in residents earning more money and having more purchasing power, resulting in an overall rise in the targeted economies.
A significant benefit of FDI in the development of human capital resources. The skills developed by the workforce through training contribute to a country’s overall education and human capital. FDI-receiving countries benefit from the development of their human resources while keeping ownership. Another significant benefit of foreign direct investment is the growth in the revenue of the target country. More jobs and greater pay usually lead to a rise in national income, which fosters economic growth. Large firms typically pay greater salaries than those found in the target country, which might increase income.
Disadvantages of Foreign Investments
Foreign investments, on the other hand, have unpropitious consequences too, for instance, it makes small-scale industries invisible in the market due to an influx of items from FDIs. Besides, it has resulted in greater pollution in developing countries since developed countries have relocated some of their pollution-producing businesses to these countries, such as the automobile industry, electronic industry. Furthermore, the local population has faced cultural shock as a result of the FDI intrusions, as the home culture has suffered a setback.
The presence of FDI has also led to inflation, and a significant amount of money is being spent on advertisements and consumer promotion, which comes at the expense of consumers forming cartels to dominate the market. TRIPs (Trade-Related Intellectual Property Rights) and TRIMs (Trade-Related Investment Measures) have made it more difficult to manufacture certain goods in other countries. India, for example, is unable to manufacture certain medications without paying royalties to the country that invented them.
Legislations on Investment in Securities
The four major legislations that govern the ‘securities markets’ are as follows:
The Companies Act, which primarily establishes the corporate sector’s code of behavior in connection to the issuing, allocation, and transfer of securities, as well as the disclosures required in public offerings.
The Capital Issues (Control) Act of 1947 was enacted in response to the war of 1943 (World War II), to channel resources to help the war effort. It was kept with certain revisions to ensure that national resources were channeled into correct lines to serve the government’s aims and priorities, as well as to protect the interests of investors.
The Central Government, which also determined the amount, kind, and price of the issued securities, had to approve the firm wanting to issue securities under this Act. The Act was repealed in 1992 as a result of liberalization, allowing for market-determined resource distribution.
Securities Contract (Regulation) Act, 1956
The major goal of this Act is to avoid unfavorable securities transactions and to establish direct and indirect oversight over almost all areas of securities trading and stock exchange operations. Under this Act, the Central Government has regulatory authority over a) stock exchanges, which is exercised through a process of recognition and ongoing supervision, b) securities contracts and c) the listing of securities on stock exchanges.
A stock exchange must comply with the standards set forth by the federal government to be recognized. On a designated recognized stock exchange, organized trading activity in securities takes place. The stock exchanges create their listing regulations, which must adhere to the Rules’ minimum listing requirements.
The Companies Act deals with the issuance, allotment, and transfer of securities, as well as numerous areas of business management. It establishes disclosure rules for public capital offerings, particularly in the areas of corporate management and initiatives, information about other publicly traded firms managed by the same people, and management perceptions of risk factors. It also governs underwriting, the use of premiums and discounts on issues, rights and bonus issues, interest and dividend payments, as well as the distribution of annual reports and other information.
SEBI Act, 1992
The SEBI is given legislative powers to a) safeguard securities investors, b) promote the development of the securities market, and c) regulate the securities market under this act. Its regulatory authority covers all companies involved in the issuance of capital and the transfer of securities, as well as all intermediaries and persons involved in the securities market.
It also has the authority to undertake investigations, audits, and inspections of all parties involved, as well as adjudicate violations of the Act. It has the authority to register and regulate all market intermediaries, as well as to penalize them if they violate the Acts, Rules, and Regulations. SEBI has complete autonomy and control over the securities market, which it regulates and develops.
Depositories Act, 1996
This Act establishes securities depositories intending to ensure free transferability of securities with speed, accuracy, and security by (a) making securities of public limited companies freely transferable subject to certain exceptions; (b) dematerializing securities in the depository mode, and (c) maintaining ownership records in a book-entry form. The Act envisions the transfer of ownership of securities electronically by book entry, rather than the securities moving from person to person, to simplify the settlement process. The Act has made all public limited companies’ securities easily transferable, restricting the company’s ability to utilize discretion in effecting securities transfers, and eliminating the need for a transfer deed and other procedural limitations under the Companies Act.
Prevention of Money Laundering Act, 2002
Money laundering is defined as acquiring, owning, possessing, or transferring any proceeds of crime; or knowingly entering into any transaction that is related to proceeds of crime either directly or indirectly, or concealing or aiding in the concealment of the proceeds or gains of crime within or outside India. The Act’s main goal is to prohibit money laundering and to provide for the confiscation of property obtained by or participating in money laundering.
However, in India, it raises a genuine national security concern about specific takeover attempts, which most other countries have blocked using special laws, revealing a critical shortcoming in Indian legislation. Thus, during Covid, India’s experience with Chinese FDI emphasizes the need of recognising national security vulnerabilities from foreign investment. Foreign Exchange Management Act, 1999 (FEMA) is the law that governs India’s foreign investments, and its preamble clearly states two macroprudential goals: enabling external commerce and payments and fostering the orderly development and maintenance of India’s foreign exchange markets. As a result, it allows the RBI and the central government to work in tandem to control capital account operations. These rules regulate who can invest through FDI, in what sectors, and for how much.
In practice, these restrictions have conformed not only to the aforementioned goals but also to other issues such as national security. While it may have served its purpose during crises, India should follow the lead of its western counterparts and create a statute particularly tailored to vet strategic FDI for national security. The legal criteria for determining when a foreign acquisition of an Indian enterprise creates serious national security dangers must be properly laid out. Theodore H. Moran outlined three types of legitimate threats arising out of foreign acquisitions –
The first threat arises if a foreign acquisition makes India reliant on a single supplier of goods, and to consider it a credible threat, it is necessary to consider not only how important such goods are to India, but also how tightly concentrated the industry is, how limited close substitutes are, and how high switching costs are.
Another threat emanates from an acquisition transferring technology or expertise to a foreign-controlled entity in a manner that is detrimental to India’s national interests.
The third concern emerges if a planned acquisition allows for the introduction of some possible capability for infiltration, monitoring, or sabotage via human or non-human agents into the provision of commodities or services critical to the Indian economy’s operation.
Given that India is a developing economy with a huge working population, one of the central government’s key goals is to attract global investment and position India as the world’s preferred manufacturing hub. The national government’s ‘Make in India’ and ‘Aatmanirbhar Bharat‘ programs work in concert with India’s liberalized FDI regulations, providing the much-needed fuel to economic growth. However, although foreign investments have their advantages, they can be detrimental at the same time. As aforementioned, overall, India’s experience with Chinese FDI emphasizes the significance of identifying and objectively addressing specific national security vulnerabilities posed by strategic FDI. This is far too sensitive a situation to be left to FEMA’s capital controls. Such challenges would be best handled by a specific statute for national security vetting of inward FDI.