E-com FDI policy: In letter or spirit?
Financial Express, March 19, 2019
By Vivek Gupta, Rajendra Nalam & Amisha Singal
As 2018 drew to a close, the year-end vacations had begun as also customary celebrations, but a last-mile twist was in store (no pun intended). Against the backdrop of litigation, enquiries by the Enforcement Directorate and impending general elections, the government issued Press Note 2 (December 26, 2018) to provide more clarity on the foreign investment policy in e-commerce. While the Press Note provided more clarity, it also shook up the status quo in a number of ways. After the customary furore, the government issued a clarification in January to reiterate that the Press Note was necessary given the instances of policy violation and circumvention—clearly, the concerns were grave. For the market, the Press Note introduced new variables in a number of ongoing deals and called 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 touchpoints (via customers, merchants, ads, jobs). While some e-commerce companies revisited existing structures, others didn’t need to change a thing. Either way, the government set a deadline of February 1, 2019, for compliance, meaning decisions had to be made quickly. So, the obvious questions arose: Would sophisticated investors and the largest companies in the world commit billions in investment with scant regard for the law of this land? Were the legacy 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: (1) policy on e-commerce, (2) policy on B2B wholesale trading, and (3) policy on 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 (for example, deep discounting). 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 debate was 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? Here is a quick summary:
(a) It introduced a new restriction on vendors (no vendor can purchase more than 25% of its stocks from marketplace or its group companies) and deleted the old one (no vendor group can comprise more than 25% of sales on marketplace);
(b) It introduced a new ownership condition, i.e. no vendor can have equity participation by marketplace or its group companies;
(c) It introduced 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;
(d) To build checks & 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 letter and spirit of law? Perhaps not. For example, an e-commerce entity is defined as one that is owned and controlled by foreign companies. Does this mean a company with 49% 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, and 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.
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. One, the Press Note is ostensibly clarificatory in nature and, therefore, there is no new rule per se that requires prospective compliance. Two, the need for a compliance certificate every year is an absolute condition for all players without exceptions.
So, who gets to decide whether compliance with the law is truly delivered in both letter and spirit; more importantly, where does this debate lead to?
On one hand, the modification of existing legal structures requires multiple considerations/costs, without explicit assurance on whether the revisions comply with the law or not. 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 even with the new guidelines, some of which are already visible. The question, however, is whether the new solutions are adequate for the continued commitment of large capital flows by foreign investors? In order to build confidence and certainty, it would be helpful if all the concerned players are involved in a consultative process to evolve a clear policy framework with a comprehensive set of FAQs. Meanwhile, fresh investments might just adopt a wait-and-watch approach even as restructuring kicks off in top gear.
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