news letter2 - 24-2-16 · experience in the reinsurance business; solvency margin as per the home...

India Unleashed

Feb 2016

Sakate KhaitanSenior Partner

Warm Regards,

In this second edition of 'India Unleashed', we take a critical look at key insurance reforms and the enabling regulations

issued by IRDAI in this regard. We hope you find India Unleashed useful. Please feel free to provide your feedback at

indiaunleashed@khaitanlegal.com.

Given the role and contribution of the insurance industry in the development of any economy, the ability of the Government to make reforms

happen was indeed a laudable step. However, the legislative process is just half the story. The mantle to take the reforms forward now lies with the

Indian insurance regulator, the Insurance Regulatory and Development Authority of India (“IRDAI”). The global insurance industry is closely

watching how IRDAI steps up to the plate on this occasion so as to fulfil Government assurances and also contributes to the growth of the sector, at

this crucial stage for the Indian economy. In the past, IRDAI has played its role with conviction and we firmly believe that IRDAI will not disappoint

this time either.

Predicting the course of an economy in the face of global turmoil is risky business. Looking back and analysing is perhaps much easier. 2015: the

year that went past evokes contrary opinions in so far as the Indian economy and polity is concerned. While some would call 2015 as a year of

missed opportunities, others, like us, believe that it was a turning point of sorts for India; especially for a sector like insurance. Capital starved and

hungry for reforms, the Indian insurance sector finally saw some positive movement with the passage of the Insurance Laws (Amendment) Act,

2015. It will not be exaggeration to state that, steering the insurance reforms through the Parliament has been the finest hour of the present

Government thus far.

Dear Readers,

‘In Brief

FDI in LLPs, in sectors which permit 100% FDI under the automatic route without performance linked conditions, is now permitted under the automatic route.

Sourcing norms have been relaxed for single-brand retail. Further, single-brand retail trading entities operating through brick and mortar stores, are also permitted to undertake retail trading through e-commerce. Indian manufacturers are permitted to sell their own branded products in any manner, i.e. wholesale, retail and e-commerce without Government approval.

Apart from the above, FDI norms in, inter alia, the banking, defence, broadcasting, plantation, air transport services sectors have also been liberalised.

One of the most radical changes is in the Construction Development sector, where the requirements of minimum capitalisation and area restrictions have been removed. Further, foreign investors can exit and repatriate investments before a project is completed, but with a lock-in of three years, or upon completion of trunk infrastructure, whichever is earlier. Transfer of stake from one non-resident to another, without repatriation of investment, is not subjected to any lock-in period or approvals. The definition of “real estate business”, wherein FDI is not permitted, has been amended to exclude earning of rent/income on lease of property not amounting to transfer, from its purview. Accordingly, foreign enterprises are now allowed to engage in the business of leasing or renting out.

After a short lull, the Indian Government has gone back to further liberalising the foreign direct investment (“FDI”) regime in 15 major sectors. These measures were introduced in November 2015 to further ease, rationalize and simplify the process of foreign investments in the country and to put more FDI proposals under the automatic route instead of the Government route, which involved significant time and resources of investors.

The much litigated issue of the power of Indian courts to pass interim orders in international commercial arbitrations if the seat of arbitration is outside India is finally settled, and unless the arbitration agreement states otherwise, the provisions pertaining to the interim order of court, court's assistance in taking evidence, and appealable orders are now also applicable to international commercial arbitrations, irrespective of situation of place of arbitration. However, courts cannot pass interim orders once the arbitral tribunal is constituted, unless interim measures of the arbitral tribunal are rendered non-efficacious. Further, once an interim order is passed, arbitration is required to commence within 90 days thereof.

The Amendment is effective from 23 October 2015, the date on which the Arbitration and Conciliation (Amendment) Ordinance, 2015 was promulgated by the President of India, and unless otherwise agreed between the parties, applies only in relation to arbitral proceedings commenced on or after 23 October 2015.

The Amendment also confers powers on the High Courts to determine the fee structure for the arbitral tribunal for domestic arbitration.

The Amendment also recognises arbitration agreements entered through the electronic mode as valid. Further, the process of arbitration has been made time bound, and a process for fast track arbitration, where no oral hearings are required, has also been introduced.

The Arbitration and Conciliation (Amendment) Act, 2015 (“Amendment”) which was notified on 1 January, 2016, puts to rest the debates regarding interim orders by Indian courts in international commercial arbitrations and also aims to make arbitration proceedings more time and cost effective.

Liberalisation gathers more steam: India Arbitration Law AmendedFurther relaxations in Foreign Direct Investment

Insurance reforms brought about by the Insurance Laws (Amendment) Act, 2015, (“Insurance Amendment Act”) in early 2015 demonstrated the Government's resolve to bite the bullet, and earned well deserved praise for the Government. However, almost one year on, the big ticket changes like increase in foreign investment ceiling, branch offices of foreign reinsurers in India and entry of Lloyd's of London that the reforms promised to usher, are yet to show tangible results. Government and the insurance regulator, Insurance Regulatory and Development Authority of India,(“IRDAI”) are working overtime to make the insurance reforms happen, and in our view, slowly but surely the Indian insurance sector will reap the dividends of insurance reforms. This article critically examines the status and progress of the key reforms that were effected by Insurance Amendment Act.

Foreign Investment in Insurance: So Near Yet So Far!

The most significant change introduced by Insurance Amendment Act was the increase in foreign direct investment (“FDI”) in Indian insurance companies. Ceiling of aggregate holdings of equity shares by foreign investors, including portfolio investors, in insurers has gone up to 49% of the paid up equity capital.

The good news of FDI hike was accompanied with the requirement of Government approval and a rider that Indian insurance companies ought to be Indian owned and controlled. Change in law was not good enough to effect the change.

An application is to be made to the Foreign Investment Promotion Board ( FIPB”), an inter-ministerial body, responsible for processing FDI proposals and making recommendations for approval. In addition, approval of Competition Commission of India - the anti-trust regulator (if applicable) and the IRDAI is also required.

With regards to “Indian owned and controlled,” IRDAI issued Guidelines on “Indian Owned and Controlled” in October 2015,(“Control Guidelines”). The Control Guidelines provide that “control” of an insurer can be exercised by virtue of shareholding, management rights, shareholders' agreements, voting rights or any other manner as per law.

The Control Guidelines specify the criteria to be adhered to by all insurers and intermediaries to ensure that they are “Indian owned and controlled”. For instance, the CEO is required to be nominated by the board of directors or by the Indian shareholder / promoter. Further, the majority of directors (excluding the independent directors) are required to be nominated by the Indian shareholder / promoter, and the board is required to exercise control over the significant policies of the company.

“

While the Control Guidelines specify that a valid quorum for a board meeting will comprise of majority “Indian directors”, it is not clear who would fall within these parameters, and possible interpretations include nominees of the Indian shareholders, Indian citizens and Indian residents. The foreign shareholder has the right to require its nominee director(s) to be present to constitute valid quorum at a board meeting.

Each insurer / intermediary is required to submit an undertaking to the IRDAI, confirming compliance with the Control Guidelines. Several insurers and intermediaries have already amended their investment agreements to be compliant with the Control Guidelines.

The Control Guidelines provide certain insights into the IRDAI's views on ownership and control. However, several questions remain unanswered. While it is evident that the IRDAI will not permit joint control, minority protection rights have not been substantially addressed. Finally, while the Control Guidelines require the board of directors to control the significant policies of the company, in practice, it is the foreign partner that provides sector expertise and domain knowledge. It is unclear as to how the IRDAI intends to permit a mechanism whereby these can be leveraged for the overall growth of the sector.

Most foreign partners have expressed their desire to increase their stake in their Indian JVs to 49%. However, at the time when India Unleased went to print only five insurers had received FIPB nod for higher foreign investment. While Control Guidelines are a step in the right direction, we hope that the IRDAI continues to remain proactive so as to ensure that this sector remains attractive and conducive to foreign investment.

Branch Offices of Foreign Reinsurers: A story with many twists, turns and surprises:

Another landmark amendment brought about by the Insurance Amendment Act was the opening up of the Indian reinsurance market to branch offices of foreign reinsurers. After prolonged deliberations and consultations with stakeholders, the IRDAI finally notified IRDAI (Registration and Operations of Branch Offices of Foreign Reinsurers other than Lloyd's) Regulations, 2015 (“Reinsurance Branch Regulations”),

lay down the procedure for setting up and registration of reinsurance branch offices of foreign reinsurers in India, and also provide the framework for their operation.

Under the Reinsurance Branch Regulations, eligible foreign reinsurers (“Applicants”) can apply for registration as a Category I or a Category II reinsurance branch office.

Registration Process

The registration process for both categories is divided into three parts, the requisition for registration application, application for registration and final grant of certificate of registration.

Eligibility criteria for an Applicant, as prescribed under the Reinsurance Branch Regulations, include, inter alia, minimum net owned funds of Rs. 5,000 Crore; minimum credit rating of good financial security characteristics; minimum 10 years' experience in the reinsurance business; solvency margin as per the home country regulator's standards. The minimum assigned capital requirement for setting up a reinsurance branch office in India is Rs. 100 Crore.

Framework for Operation

The Reinsurance Branch Regulations lay down the basic framework for operation of the Indian reinsurance branch offices, which include the regulation of the appointment of CEO and other key management personnel; opening of additional offices; accounting; solvency margin requirements; investment; retention limits, etc.

Further, the Reinsurance Branch Regulations specifically provide that such branch offices can outsource functions such as back-office servicing, investment, IT, accounts, marketing, human resources, administration and publicity. No other functions of the branch offices are permitted to be outsourced.

‘Order of Preference’ for cession by Indian insurers is one of

on 23 October 2015. Reinsurance Branch Regulations

India Unleashed

Courtesy: Google Images

Insurance Reforms: Unfolding story of opportunity and challenges

the major subjects of debate within reinsurance circles. The Reinsurance Branch Regulations, recently amended in this regard, provide for primacy of the Government owned General Insurance Corporation. As per the Reinsurance Branch Regulations, Indian insurers have to first obtain “best terms” for their facultative and treaty surpluses from qualified Indian reinsurers, i.e., Indian reinsurers having a minimum credit rating of atleast good financial security characteristics for the previous three years; and atleast three Category I reinsurance branch offices. Once these “best terms” are obtained, Indian insurance companies have to offer the same to reinsurers in the prescribed order of preference, i.e., first to the qualified Indian reinsurers and thereafter to Category I reinsurance branch offices in the first level. In the second level, they are to be offered to the other Indian reinsurers and Category II reinsurance branch offices. Once offers have been made to all the entities in the first two levels, Indian insurers are permitted to offer their facultative and treaty surpluses to branch offices of foreign reinsurers set up in Special Economic Zones, and the balance to Indian insurers and overseas reinsurers.

The industry is currently debating whether the “best terms” can be obtained from entities apart from the ones specifically listed. Further, operational clarity is awaited from the IRDAI. Top global reinsurers like Hannover Re, Swiss Re, Munich Re, SCOR and RGA have already made applications to the IRDAI. However, it seems unlikely that these branch offices of foreign reinsurers will be fully operational before 1 April 2016.

Lloyd's Entry – The Devil will be in the Detail:

The much awaited entry of Lloyd's established under the Lloyd's Act, 1871 (“Lloyd's UK”) and its members into India to undertake reinsurance business was facilitated through the Insurance Amendment Act. Definition of “insurer” post amendment includes branches of Lloyd's UK and its members established in India.

However, given that Lloyd's is not a typical company writing reinsurance business but operates as a market place where multiple members join together as syndicates to carry on reinsurance, IRDAI decided to bring out separate regulations for Lloyd's entry into India rather than including it within the Reinsurance Branch Regulations.

Although the IRDAI regulations for the setting-up and operations of the branch office of Lloyd's UK and its constituents in India have been formulated and approved by the IRDAI board in its meeting dated 4 January 2016 (“Draft Lloyd's Regulations”), formal notification of the Lloyd's regulations is still awaited.

The Draft Lloyd's Regulations prescribe a three-stage process for registration of Lloyd's India, similar to that under the Reinsurance Branch Regulations. Further, the eligibility criteria for Lloyd's UK to be able to set up Lloyd's India are also similar to those required for Applicants under the Reinsurance Branch Regulations. Further, at the time of registration, Lloyd's UK also has to provide a letter of comfort that the holders of reinsurance policies issued by a member of Lloyd's India shall have equivalent recourse to the Lloyd's Chain of Security, including the Central Fund at all times. This will give comfort to holders of reinsurance policies with the Lloyd's branch office in India.

The Draft Lloyd's Regulations also provide the process for registration of the constituents of Lloyd's India, i.e., its members, service companies and syndicates, with IRDAI. Further, the Draft Lloyd's Regulations also provide for the operations framework of Lloyd's India.

The full effect of the Lloyd's regulations can only be analysed once the final regulations are notified. IRDAI will be required to balance the competing interests of the Indian reinsurer, the branch offices of foreign reinsurers and Lloyd's India constituents and provide a beneficial regulatory framework.

Other Forms of Capital: Flexibility

Another important change introduced by the Insurance Amendment Act is the option available to insurers to raise capital by issue of instruments other than equity shares. IRDAI (Other Forms of Capital) Regulations, 2015 (“Capital

India Unleashed

Regulations”) issued pursuant to this change in law, permit Indian insurers to raise capital through fully paid-up and unsecured preference shares, debentures, and any other debt instruments as may be permitted by the IRDAI (“Capital Instruments”).

Prior approval of the IRDAI is required for issue of such Capital Instruments, and such issuance is to be carried out through private placement to Indian promoters, Indian investors and foreign investors in accordance with securities regulations and exchange control laws, if applicable.

However, such issue of Capital Instruments is subject to certain conditions. For instance, Capital Instruments must not exceed 25% of the total paid-up equity share capital and securities premium account and 50% of the net worth of the insurer. Further the Capital Regulations also lay down the minimum maturity period of Capital Instruments, and the subordination of claims on Capital Instruments vis-a-vis claims of policyholders and creditors.

Further, Capital Instruments may be issued with a call option, but not with a put option. The IRDAI has also prescribed an amortisation schedule for Capital Instruments for the purpose of calculating the “available solvency margins” for insurers.

The Capital Regulations, in our view, are a positive step taken by the IRDAI to lend flexibility to insurers to structure their capital requirements. However, certain issues remain to be ironed out. For instance, in case of non-convertible debentures or pure debt instruments, amendments in exchange control regulations will be required if the regulators intend to extend such issuance to foreign investors. Similarly, in case of convertible debentures or quasi-equity instruments, it remains to be seen whether the exchange control regulator will consider such instruments in calculating the total FDI in the insurer.

Courtesy: Google Images

Insurance Intermediaries

Apart from the above, the Insurance Amendment Act has also brought about a number of changes for insurance intermediaries; key ones being the introduction of open architecture and removal of statutory caps on commissions paid to intermediaries.

New regulatory regime based on open architecture framework for corporate agents has been ushered in the through the notification of the IRDAI (Registration of Corporate Agents) Regulations, 2015, which will be effective from 1 April 2016. Draft regulations on commission and remuneration to insurance agents and insurance intermediaries have also been issued by the IRDAI and at the time of going into press the final regulations had not been notified.

Conclusion

Insurance Amendment Act has been a game changer in more than one way and if correctly implemented, has the potential to change the entire insurance landscape of India. While the Government has played its part by changing the law, the onus is now on IRDAI to make the reforms a success by framing and implementing regulations. IRDAI on the other hand, faces the challenge of addressing the concerns and balancing the interests of various stakeholders including the policy makers, the different constituents of insurance industry and the policy holders at large by providing a level playing field. We strongly believe in the future of Indian insurance sector and are confident that IRDAI will rise to the challenge and deliver on expectations!

As notified in February 2016, a startup is an entity incorporated in India, not more than 5 years old, with an annual turnover not exceeding

INR 25 crore in any year. Further, such entity should be engaged towards the development/commercialisation of new products, processes

or services driven by Intellectual Property (IP) or technology, that add value to customers or workflow. Eligibility in this regard is determined

either by support from an incubator, funding that endorses the 'innovative nature' of the business or ownership of an Indian patent.

What is a startup?

With the objective of encouraging the fledgling “start-up” activity, the Government of India unveiled the ambitious 'Startup India: Action Plan'

amidst pageantry and fanfare in January 2016. While Indian startups were hitherto entitled to certain tax breaks and other benefits, there

was no broad policy until now that underscored the Government's commitment to promoting innovation and entrepreneurship.

The key takeaway from this is that any foreign national visiting India whether on business or pleasure must avail an appropriate visa prior to arrival. Although the introduction of the new 'e-tourist visa' program (launched with fanfare by the Government and now extended to over 100 countries) has resulted in a sizeable surge in the number of foreign nationals visiting India, it is imperative that certain creases in the system be ironed out as soon as possible. Whilst some would expect that Indian authorities could have been more lenient in authorising Bloom with a TLP in order for him to continue his visit in India, others would state that Bloom and his team should have been more heedful in ensuring the approval of his visa prior to landing in India.

On Bloom's arrival in New Delhi, immigration authorities denied him entry on the grounds that his 'e-tourist visa' which was applied for in November 2015 was not cleared for approval. Despite having the authority to permit Bloom to remain in India for a period of 72 hours by means of issuing a discretionary Temporary Landing Permit (TLP), it is believed that Indian immigration authorities were insistent on his departure. Bloom was forced to leave India and return to the UK the very same night. It was not until the intervention of India's External Affairs Minister, Sushma Swaraj that Bloom finally was granted a fresh visa by the Indian authorities in the UK and swiftly arrived back in New Delhi to continue with his visit.

Hollywood superstar Orlando Bloom had a brush with Indian immigration recently when he was made to fly back to London after landing in New Delhi without a valid visa! Even the glamour quotient couldn't cut ice with Indian immigration officials at the New Delhi airport notwithstanding the fact, and ironically so, that Bloom was visiting India on an invitation from the Indian Government for the promotion of tourism in India!

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This briefing has been written for the general interest of our clients and business contacts. It is not intended to be exhaustive or a substitute for legal advice. We accept no legal liability for any errors or omissions.

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©Copyright 2016 Khaitan Legal Associates. [Volume: 2 Issue: 1] All rights reserved.

Regime overview

While the Indian Government must be lauded for focussing on startups, the real test would be how the policy is implemented in practice and how amendments are made to the various legislations. Budding entrepreneurs can however rejoice at the easing up of the compliance burden and costs – building world class products and processes can be their single minded focus in the initial years!

Broadly, the policy envisages the following for Indian startups:• Funding assistance – Government to set up a Fund of Funds with a corpus of INR 10,000 crore; • Tax benefits- (i) 3 year income tax exemption for startups (provided no dividend is distributed) (ii) tax exemption on capital gains if invested

in the above Fund of Funds (iii) tax exemption for receipt of any investment in excess of fair market value of the startup's shares. Certification from an Inter-Ministerial Board required to claim tax benefits;

• Reducing compliance cost – self certification as regards 9 labour laws and environmental laws and faster exit route envisaged;• Creation of a 'Startup India Hub' to collaborate with various players in the startup ecosystem; • Introduction of a mobile application and portal for easy registration of startups, obtaining approvals related information;• IP - Fast tracking of patent applications, 80% rebate in fees, setting up a panel of facilitators to assist in filing IP applications.

Vaibhav is a transactional lawyer and has experience of over fifteen years which includes advising start-up companies as well as large multinational organisations on their investment and strategic decisions. Being dual qualified in India & UK, Vaibhav is a recognized expert on cross-border transactions, foreign direct investment, joint ventures, infrastructure, multi-jurisdictional projects and has also been involved in several large litigation & arbitration matters.

Khaitan Legal Associates are delighted to announce the expansion of our team in Mumbai with two new partners Vaibhav Shukla and Ami Parikh.

India's New Startup Policy

In Other News…

Specializing in private equity, cross border transactions, joint ventures, acquisitions, securities laws, general corporate advisory & compliances and commercial transactions, Ami has represented corporates in sectors such as insurance, IT, manufacturing & distribution, FMCG & NBFCs & has advised several private equity & venture capital firms, foreign institutional investors & high net worth individuals.

Incredible India: Indian immigration, a regime to be made more credible

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