E-commerce FDI flows likely to be interrupted even though restructuring kicks off in top gear

By Vivek Gupta, Rajendra Nalam & Amisha Singal

As 2018 drew to a close, the year-end vacations had begun as also the customary celebrations, but a last-mile twist was still in store. Against the backdrop of litigation, enquiries by Enforcement Directorate and impending general elections, the government issued a press note in December to provide more clarity on foreign investments in e-commerce. While the press note certainly provides more clarity, it also shook up the status quo in a number of ways. And after the customary furore, the government issued a clarification earlier this month to reiterate that the press note was necessary given instances of policy violation and circumvention. For the market, the press note introduces new variables in a number of ongoing deals and calls for significant restructuring efforts.

While players in the e-commerce sector operate using complex structures, they are all household names thanks to the huge investment in this category and the high number of touch points (via customers, merchants, ads, jobs). Some of the e-commerce companies are fervently revisiting existing structures, but some others don’t need to change a thing. Either way, the government set a deadline of February 1 2019, for compliance, meaning that decisions had to be made quickly. So the obvious questions arise—would sophisticated investors and the largest companies in the world commit billions in investment with scant regard for the law of this land? Are the existing structures and arrangements employed by e-commerce companies fundamentally inimical to the interests of the Indian market (notwithstanding consumers’ affection for discounts and freebies)?

To understand more, one should see that the policy on foreign investment in e-commerce has three broad pillars—policies on e-commerce, B2B wholesale trading and what counts as foreign investment and what doesn’t. While it is perfectly okay for foreign investors to own 100% of e-commerce ‘marketplaces’, there is a specific bar on owning inventory, B2C sales and influencing product prices directly or indirectly. It is probably a safe bet to say that no company worth its salt will engage in business practices that blatantly flout these guidelines. However, the challenge seems to be that e-commerce players comply with the letter of the law, but not necessarily with its spirit. So, what has the press note done to cause concern?

It introduces a new restriction on vendors (no vendor can purchase more than 25% of its stocks from a marketplace or its group companies) and deletes the old one (no vendor group can comprise more than 25% of sales on marketplace). It introduces a new ownership condition: no vendor can have equity participation by marketplace or its group companies. It introduces a test of fair, non-discriminatory and arms-length principles into arrangements between the vendors and the marketplace/its group companies, apart from a ban on exclusive sales arrangements. To build checks and balances, it requires a certificate/report from the statutory auditor confirming that the company complies with the regulations.

So, does the press note answer all the questions and provide the clarity needed for companies to comply with both the letter and spirit of law? Perhaps not. For example, an e-commerce entity is defined as one which is owned and controlled by foreign companies—does this mean that a company with 49% of foreign investment and board representation doesn’t need to comply with any of the new guidelines? The press note uses terms such as ‘equity participation’, ‘group companies’, ‘direct or indirect equity participation’, ‘common control’ etc, some of which are defined terms while others are not. Who decides whether a certain practice is par for the course or discriminatory? What stops a disgruntled vendor or competitor from alleging malpractices? How would a partner of an audit firm certify compliance of every business practice? There are many questions left to be answered.

A related question concerns grandfathering of existing players—there is a thought process that the policy should only operate prospectively with respect to fresh FDI inflows and, therefore, existing structures do not require change. While this is a welcome view for companies that have made significant commitments based on regulations prevailing at the time of investment, it is subject to two obvious challenges. Firstly, the press note is ostensibly clarificatory in nature and, therefore, there is no new rule per se that requires prospective compliance. Secondly, the need for a compliance certificate every year is an absolute condition for all players.

So, who gets to decide whether the compliance with the law is truly delivered in both letter and spirit; more importantly, where does this debate lead? On one hand, the short February 1 deadline and the modification of existing legal structures require multiple considerations/costs without explicit assurance on whether the revisions comply with the law or not. There is a strong case, therefore, to extend the deadline by a few months. On the other hand, we need to consider the philosophical issue of integrity and consistency of Indian policymaking, which is essential to attract capital to create infrastructure, benefits for consumers and job opportunities.

To conclude, one would argue that there are several solutions to comply with even the new guidelines. The question, however, is whether the new solutions are adequate licence for the continued commitment of large capital flows by foreign investors. In order to build confidence and certainty, it would be helpful if all concerned players are involved in a consultative process to evolve a clear policy framework. Meanwhile, fresh investments are likely to adopt a wait-and-watch approach even as restructuring kicks off in top gear.

Gupta is partner and national head of M&A tax, Nalam is partner of deal advisory and Singal is director of deal advisory in KPMG, India

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