FDI Reforms in E-Commerce: What Do They Entail?

In a post
on this Blog
earlier this month, Satyajit Gupta and Saurabh Sharma
elaborately discussed the background to the foreign direct investment (FDI)
policy in the e-commerce sector. Ambiguities in the policy have not only given
rise to uncertainties to players in the sector, but have also resulted in
multiple rounds of litigation. As they demonstrate, the dominant e-tailers have
gravitated towards the “marketplace” model of e-commerce, in some ways by
taking advantage of the ambiguities in the policy. Yesterday, the Government
issued Press
Note No. 3 (2016 Series)
, which clarifies the position on FDI in e-commerce,
and legitimizes the marketplace model, but with some significant riders. The
purpose of this post is to examine this important FDI reform with a view to
determining the extent of impact it may have on the e-commerce sector.
Pre-existing Position
Under the FDI Policy
Circular
, FDI has permitted up to 100% in e-commerce activities. Importantly
though, this covered only B2B trading and not retail trading (i.e. B2C). B2C
trading was permitted through limited ways such as where (i) a manufacturer of
products in India could sell online, and (ii) a single brand retail entity
could sell products online as a means of supplementing its brick and mortar sales.
However, pure-play B2C trading activities were out of bounds.
In order to overcome these restrictions, as Satyajit
and Saurabh point out, various e-commerce companies began carrying out retail
trading through the marketplace model whereby the companies would only provide
a technology platform to enable trades to take place between various sellers
and purchasers of goods. One may consider this to be a form of regulatory
arbitrage. Although investigated by the authorities and challenged in courts,
there was nothing unequivocal to indicate the illegality of the model.
It is in this milieu that the Government yesterday
issued Press Note 3 to clarify the regulatory position regarding FDI in B2C
e-commerce. The current uncertainty has been put to an end, as the Government
has declared the marketplace model to be an acceptable one so long as it has
been accompanied by compliance with certain stringent conditions the Government
has prescribed.
Nature of the Reforms
The principal effort of Press Note 3 is to define
e-commerce and to bifurcate it in to the (i) marketplace model and (ii) inventory
based model. It then goes on, from an FDI perspective, to conditionally embrace
the former while conclusively shunning the latter.
The press note defines marketplace model as one that
provides “an information technology platform by an e-commerce entity on a
digital & electronic network to act as a facilitator between a buyer and a
seller”. It also defines the inventory based model as one “where inventory of
goods and services is owned by e-commerce entity and is sold to the consumers
directly”. While 100% FDI under the automatic route is permissible under marketplace
model, FDI is prohibited under the inventory based model: two diametrically
opposing results depending upon which model is chosen.
More importantly, the liberal FDI in the marketplace
model is subject to several conditions. It would be helpful to touch upon some
of those. E-commerce entities are entitled to provide support services to
sellers. However, the policy clearly prevents them from taking on ownership
over the goods sold. If they do so, they will be treated instead as an
inventory based model (which will cause them to be in breach of the FDI
policy).
A condition that has attracted some level of
controversy relates to that fact that no more than 25% of an e-commerce entity’s
sales can relate to one vendor or its group of companies. Evidently, this is an
anti-abuse provision, in order to ensure that the true nature of the
marketplace model is preserved, and that an inventory based activity is not
carried on in the garb of a marketplace. This would prevent entities from
creating marketplaces that are effectively extensions or outsourced vehicles of
trading arms. This would call into question some of the currently marketplace
structures, which operate as platforms for group entities that effect the sales
of the goods.
Consistent with the marketplace model, the responsibility
for sales, after-sales services and customer satisfaction will lie with the
sellers, and cannot be assumed by the e-commerce entity. Similarly, any warranties
or guarantees relating to the product are only the responsibility of the sellers.
Another condition that has invoked a great deal of
discussion relates to pricing and discounts, which would now lie only with the
sellers of the goods. The policy is explicit in stating that the e-commerce
entities “will not directly or indirectly influence the sale price of goods or
services and shall maintain level playing field”. This is ostensibly with a
view to ending the discount wars that are prevailing between various e-tailers
and which enable them to compete more effectively with brick and mortar
traders. In other words, the marketplace model is a true reflection of the fact
that the e-commerce entity provides nothing but the platform, and can in no way
influence or intervene in the commercial terms of the transaction, which is
purely a matter between the seller and the buyers of the goods. While the
underlying concern behind this seems to be to protect small businesses and
brick and mortar stores against discounted products offered online, it remains
to be seen how this condition can be implemented. How does one determine “influence”,
whether direct or indirect that the e-commerce entity can exercise over the sellers?
Much would be left to the discretion of the regulators, which may therefore
leave some uncertainty in the process.
Conclusion
The Press Note is welcome in that it clarifies the
position regarding FDI in e-commerce, which has been shrouded in uncertainty
until now. It is likely to reduce any possibility of regulatory arbitrage that has
been rampant in the sector. Activities in the form of the marketplace model
that were being carried out under the prevailing uncertain regime have now been
legitimized with conditions. While some of the existing players may now have to
reorient their affairs to meet with this more onerous conditional regime, it
may open up the space for other players and investors who have been waiting in
the wings for a clearer regulatory regime.
The policy has received opposing reactions with
equal strength. On the one hand, some believe that the heavy conditionalities
accompanying the marketplace model make it virtually unviable. Others believe
that the opening up of the e-commerce sector itself poses a threat to domestic
brick and mortar businesses. This is not surprising given that FDI in the
retail sector has been an emotive issue for a number of years. While the
earlier debates were largely steeped in the perceived threat of large shopping
chains owning mega stores across the country, this round has been focused on
sales through electronic means. Apart from a variation in the mechanics of how
the browsing and shopping takes place, the real issues and controversies are
rather similar. Given the polemic nature of the issue, the debates are likely
to continue, as are the legal challenges before courts.

About the author

Umakanth Varottil

Umakanth Varottil is an Associate Professor at the Faculty of Law, National University of Singapore. He specializes in corporate law and governance, mergers and acquisitions and cross-border investments. Prior to his foray into academia, Umakanth was a partner at a pre-eminent law firm in India.

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