LEGAL VIEWPOINT: Foreign Direct Investment (FDI) – What to know? by Dr AbdelGadir Warsama Ghalib, Principal Legal Counsel, Bahrain

Dr. AbdelGadir Warsama Ghalib, Principal Legal Counsel, Bahrain.

There is much talk about FDI and their benefits to the global and national economy of many countries. That, almost many countries, if not all, eagerly look for investments from different parts and in different products or services. There are many definitions to the activity of FDI, however, according to the IMF and OECD definition, direct investment reflects the aim of obtaining a lasting interest by a resident entity of one economy (direct investor) in an enterprise that is resident in another economy (the direct investment enterprise). The “lasting interest” implies the existence of a long-term relationship between the direct investor and the direct investment enterprise and a significant degree of influence on the management of the latter. Direct investment involves both the initial transaction establishing the relationship between the investor and the enterprise and all subsequent capital transactions between them and among affiliated enterprises, both incorporated and unincorporated.

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An IMF Manual defines the owner of 10% or more of a company’s capital as a direct investor. This guideline is not a fast rule, as it acknowledges that smaller percentage may entail a controlling interest in the company. But the IMF recommends using this percentage as the basic dividing line between direct investment and portfolio investment in the form of shareholdings. Thus, when a non-resident who previous had no equity in a resident enterprise purchases 10% or more of the shares of that enterprise from a resident, the price of equity holdings acquired should be recorded as direct investment. Based on this, any further capital transactions between these two companies should be recorded as a direct investment. When a non-resident holds less than 10% of the shares of an enterprise as portfolio investment, and subsequently acquires additional shares resulting in a direct investment (10% of more), only the purchase of additional shares is recorded as direct investment in the Balance of Payments.

Concerning the terms direct investor and direct investment enterprise, as per the definition of the IMF and the OECD, the direct investor may be an individual, an incorporated or unincorporated private or public enterprise, a government, a group of related individuals, or a group of related incorporated and/or unincorporated enterprises which have a direct investment enterprise, operating in a country other than the country of residence of the direct investor. A direct investment enterprise is an incorporated or unincorporated enterprise in which a foreign investor owns 10% or more of the ordinary shares or voting power of an incorporated enterprise or the equivalent of an unincorporated enterprise. Direct investment enterprises may be subsidiaries, associates or branches. A subsidiary is an incorporated enterprise in which the foreign investor controls directly or indirectly (through another subsidiary) more than 50% of the shareholders’ voting power. An associate is an enterprise where the direct investor and its subsidiaries control between 10% and 50% of the voting shares. A branch is a wholly or jointly owned unincorporated enterprise. It should be noted that the choice between setting up either a subsidiary/associate or a branch in a foreign country is dependent, among other factors, upon the existing regulations in the host country. National regulations are often more restrictive for subsidiaries than for branches, but this is not always the case. Countries looking for FDI, mostly look for all potential entities.  

The OECD recommends in its Benchmark definition that for the existence of direct investment relationship the “full consolidated system” should be followed. In other words, it means that when there is a cascade of participations, the percentage of the parent company in any affiliated companies should be calculated assuming the 100% of the subsidiaries and the corresponding percentage of the associates.

 FDI, play an important role in the economic development, wherever they go. They achieve great results through transfer of technology, exchange of minds and views, incite local enterprises through competition opportunities and so forth. However, they need to cater for local environment and local priorities. In other words, they have to equalize between their interests and the local national interests. Wise balance will give credit to both parties including the continuity of the relationship.

Dr. AbdelGadir Warsama Ghalib is Founder & Principal Counsel at Dr. AbdelGadir Warsama Consultancy.