India: An Attractive Investment Destination

Monday, November 2, 2009 - 01:00

Editor: Please describe your personal background.

Hussain: I came to the U.S. in 1979 at a young age so I've grown up basically in New York, first in New York City and then in upstate New York. Most of my childhood summers were spent visiting relatives in India. Nowadays, I visit India several times a year, though mostly for business.

Editor: Please describe your practice.

Hussain: My practice divides into two major areas: the first is corporate transactional work and the second is fund formation. The transactional work focuses on helping investment funds and multinationals, like GE or Lowes, do business in emerging markets by making investments in local companies, setting up their operations and forming joint ventures or partnerships in emerging markets. The fund formation work deals with helping funds create efficient investment structures for investing into and raising money in emerging markets.

Editor: Are these multinationals interested in establishing a presence in India?

Hussain: Often the aim is to establish a presence in India. However, there are times when the companies are not targeting the Indian market, per se - U.S. companies often contract for services and incorporate components sourced in India for use outside of the Indian market. For example, Bharat Forge is one of the largest metal-forging companies in the world and supplies parts to various car manufacturers. Also, companies like Infosys make most of their money providing outsourcing services to clients outside of India.

Editor: What liberalization has occurred since 1991 in terms of foreign ownership?

Hussain: The collapse of the Soviet Union has had a profound effect on India. Without the Soviet Union to turn to for assistance with its internal economic pressures, India applied to the IMF for a loan. The IMF, in granting the loan, forced India to liberalize what was essentially a socialist economy and break up state-owned infrastructure. This was one of the key instigators of India's growth. More powerful, perhaps, was the change in the average person's confidence in the Indian economy - many people began to feel that, with entrepreneurial effort, they too could benefit from the economic opportunities afforded by this liberalization. While there are still many challenges, India's economic growth has made life better for the average person.

Editor: Doesn't India still have an unfavorable trade balance?

Hussain: Yes, and this imbalance has been growing. A large component of the trade imbalance is energy. The energy required to support such a fast-growing economy forces India to look abroad for carbon-based fuels. India is also aggressively exploring non-carbon alternatives, such as nuclear and renewable energy sources.

Editor: What Indian industries still preclude foreign ownership of any kind? Or confine foreign ownership to a minority stake?

Hussain: Although India largely allows foreign ownership, there are still restrictions in some areas such as defense-related industries and in the power industry. The one, perhaps less obvious, area where foreign investment is restricted is the retail sector; India does not allow foreign ownership of multi-brand retail stores. For instance, Walmart cannot itself open a retail store in India, although single-brand retailers, such as Gap, can open retail stores and own up to 51 percent of the Indian entity. What tends to happen, such as in the Walmart example, is that a joint venture is formed at the wholesale level, letting the Indian partner take care of the retail aspects of the JV.

Editor: Under the laws of what jurisdictions are deals relating to investing in Indian properties done by the large investment funds and multinationals, such as GE?

Hussain: In most of these situations, Indian law applies - particularly if the investor is actively coming to India to make an investment that targets the local market. The problem is that the Indian legal system moves at a glacial pace and, therefore, no one wants to use India's judicial system in the business context. Accordingly, arbitration is a booming area.

We make efforts in the deal documents to remove any dispute from the local courts by specifying binding arbitration before an arbitration tribunal. London, Singapore and the U.S. are often the preferred arbitration jurisdictions, and the arbitrators will often apply Indian law.

Editor: Is it a problem having an Indian court enforce an arbitral decision?

Hussain: Generally it is not a problem, although it can take time. However, it's wise to specify the dispute resolution and enforcement mechanisms within the contractual agreements themselves - usually in much more detail than would typically be done in a U.S. transaction. For instance, such provisions might specify how certain arbitration awards would be automatically paid out of the revenue stream of the JV.

Editor: When you are representing a party in an arbitration, do you align with an Indian firm? Do you have a certain group of Indian firms that you call on for that purpose?

Hussain: We have a handful of firms that we work with closely because we do not and cannot practice Indian law. The deals we work on are necessarily cross-border - most often U.S.-Indian, U.K.-Indian, European-Indian or China-Indian - so we serve as international counsel and coordinate the various local law aspects and architect the transaction as a whole.

Editor: Please describe the recent 2008 modifications made by the Securities and Exchange Board of India (SEBI) to liberalize investment by foreign institutional investors and unregistered foreign investors in the Indian securities market. Also, describe the use of Offshore Derivative Instruments or participatory notes.

Hussain: Participatory notes, or p-notes as they are often called, are derivative instruments whose value is based on an underlying Indian security. They were a simple way for foreign funds to participate in the Indian market without having to comply with the somewhat onerous Indian foreign investment requirements, by purchasing the p-notes from sellers who have registered as foreign institutional investors ("FIIs") in India. The problem is that p-notes are somewhat opaque financial instruments because the underlying owner and the details of their investment strategies are not known to the Indian regulator. It is impossible to know, for instance, whether the ultimate owner was shorting an Indian security or the total volume of their holding. Prior to 2007, these p-notes made up a relatively small portion of the total inflow of foreign capital into the Indian market. However, as these p-notes became a larger part of capital flows and involved more multi-tiered derivative structures, SEBI and RBI wanted to understand the nature of the foreign inflows.

In 2007, changes were made in the regulatory system to require more transparency in the p-note market. SEBI banned FIIs from issuing participatory notes with underlying derivatives to offshore unregistered investors. SEBI also capped the amount of p-notes an FII could issue to 40 percent and required that any offshore investors holding p-notes with underlying derivatives unwind their positions within 18 months. The regulators were in essence saying: we want foreign investors to come into our market, but we want the right kind of foreign investors and the right kinds of instruments.

These measures came into effect at the peak of the market when India was the number one foreign direct investment destination worldwide. With the worldwide economic collapse a few months later, the Indian government realized that these restrictions had a very chilling effect on foreign investors and, in 2009, the regulations were reversed to once again allow offshore investors not registered with SEBI to invest in Indian participatory notes with underlying derivatives and the 40 percent cap on the off-shore derivative instruments that FIIs may issue was removed.

An interesting item to note is the different approach that the regulatory agencies in India take compared to their American counterparts. Regulatory agencies like SEBI and RBI become intrinsically involved in the nuts and bolts of policy making much more so than in the U.S. (that is, at least prior to 2009 in the U.S.) and have a history of setting forth regulations and then back-tracking or tweaking them as things change in an effort to fine-tune them to market conditions.

The reason the Indian regulators play such a hands-on role may be due to the significant role that foreign investment plays in India's economic growth. Most of India's growth has been either organic or through foreign investment unlike the central-bank-financed growth of many emerging economies.

Editor: Would you say India has a federal-type government like the U.S. or do the states have a loosely coordinated union?

Hussain: The Indian federal government does have a good deal of power but there is, perhaps, a more diverse set of political players that it has to deal with at the state level. Some of the state governments, such as Kerala, have a long history of socialism, and while Kerala has been very successful in battling illiteracy and infant mortality, it views economic growth differently from the way the federal government does.

From a business perspective, I feel that the U.S. and India have a lot in common. A large percentage of the younger generation driving the economic growth in the country were trained and educated in the U.S. and have taken their experience back with them.

Editor: How much more difficult is it to do a merger deal in India in terms of institutional barriers - licenses, etc. - than in the U.S.?

Hussain: Let's look at two separate big-picture issues - the legal and the practical. The laws themselves have been in flux: the take-over code, for instance, has gone through numerous iterations. Add to this that the various regulatory agencies often have differing views of how the rules are applied and you may have significant uncertainty when contemplating M&A in India.

From a practical perspective, doing an acquisition requires more legwork. For instance, diligence is sometimes harder to conduct because Indian companies are often less organized than their American counterparts (although this is less true of the larger companies). For example, documenting a chain of title for real estate, which is relatively easy in the U.S., can be a difficult process in India. Also, employment laws in India can make it more difficult to restructure a company.

Good counsel will have various tools to handle these uncertainties, but M&A transactions do take longer in India.

Editor: What barriers, legal and institutional, do you see as posing an impediment to India's long-term economic growth? What are the great benefits to foreigners who invest in India?

Hussain: In spite of India's phenomenal growth, a large portion of the rural Indian population still lives in poverty. Until rural India benefits from the same growth that the metropolitan areas have enjoyed, the country will not be able to move toward its goal of consistent, long-term growth and there will be growing discontent. Another big problem is energy. India's growing energy needs have been pushing generating capacity to its limits and are a gating issue to any long-term growth. Lastly, corruption is still a factor in both the public and private sector. For instance, there is a significant amount of insider trading in India, and while many of the rules necessary to curb these activities are in place, there is inconsistent enforcement.

These very notable issues aside, there are very few opportunities in the world that are as large as the India opportunity: with a population of almost 1.2 billion, the market is enormous; the number of skilled, English-speaking people in the workforce is impressive; and the government has proven to be very stable. Most economists agree that India will have solid, stable growth for the next 20 to 30 years. Investing at the ground floor of the growth phase of the Indian economy is a once-in-a-lifetime opportunity. There are very few investment opportunities that can compare to the Indian market in the long term.

Please email the interviewee at ahussain@akingump.com with questions about this interview.