What are Investment Laws and Policies?
Most nations, especially developing countries depend largely on foreign investments for economic growth and globalized trade relations. In order to regulate these, nations and businesses develop a framework of rules and guidelines called the Investment Policy which focus on encouraging private sector investments which will fuel the economy and financial condition of the country or business, and will lead to conditions of sustainable development for the profitable expansion of the investor as well[1]. A broad objective behind these policies is to strengthen the financial stance of a country and its citizens or a business and its employees[2].
These policies also contain guidelines that inherently answer any questions that investors may have with regards to the present economic condition, quality of financial and policy-making institutions, and the norms and general practices in evaluating feasibility[3]. These policies attempt to facilitate the active involvement of domestic and foreign companies, businesses and labour to effectively carry out these objectives.
A report by the UNCTAD[4] stated that as many as 108 nations had well-developed investment laws, of which 90 were developing countries focusing on globalizing their economy. Further, some countries such as China and Japan have more than one investment policy where each dealt with specific components for investments. Most countries prescribe uniform guidelines for both regional and foreign investors, while some[5] have policies that make very little to no mention of domestic investors.
The International Monetary Fund defines investment policies as laws, regulations and norms in a country that direct how investments can be made in such a way that domestic economy and public benefits are the prime focus, thus encouraging or discouraging investment, especially foreign investments[6]. This could include directives on how investors must be dealt with in a transparent manner, or may encompass laws for compensation in case of default and appropriate modes of dispute resolution[7].
While investment policies are commonly studied in the context of integrating economies, certain private and public organizations also draft investment policies to specify the investment objectives to be adopted. These company policies aim at describing the guidelines that are to be adopted whenever investments are made with respect to its assets. By drafting these within a company, the Board and company’s investment committee are advised on how to act when markets are volatile. The policy could also deal with a framework that can guarantee better ROI opportunities, while focusing on reducing capital expenditure by targeting investment opportunities that have more risk to reward[8].
Factors that Affect the Drafting of an Investment Policy
Most nations develop investment policies and the major differentiating factor is how detailed and formalized it is. Some nations may simply adopt ad-hoc policies based on the regionalized markets and investment decisions of the past which had resulted in certain return, yield, maturity on investment etc[9]. The factors that affect this decision are[10]:
- Since the amount of investment made by a foreign company depends on the interest rates prevalent in the particular sector or State, where higher rates mean higher rates of return due to more opportunity cost, policies are formulated based on this in such a way that the value of an investment is made worthwhile when the rate of return is in excess of the rate of interest[11]. The policy must also regulate the rate such that the increase in interest rates is gradual and uniform to encourage more profitable opportunities for foreign investors, rather than an unregulated steep rise which will make the environment less encouraging.
- The policy must also regulate the rate of change in interest rates. When a foreign investor decides to take an opportunity prior to the change in rates, the company will remain unaffected. However, future investment decisions will then depend on probable changes in the rate, and a policy that allows a longer, unregulated duration for such change to take effect will simply create a discouraging opportunity for future investments.
- The policies must focus on better protection of investments irrespective of present economic conditions in the respective country. If there is a possible recession, foreign investors may decide against opportunities even if interest rates reduce and the provisions in the policy must protect investors under such circumstances.
- The policy must also directly depend on the rate of economic development of the country. When a foreign company invests, it sets goals of demand and when this drops because of economic deficits, the company may choose to cut back. Similarly, if the economy grows, the amount of investment will increase.
- The policy provisions must always be positive so that they create a sense of confidence amongst investors. Effective regulation of costs of investment, the economic rates and rates of demand will lead to better investment opportunities since this is based on the economic and political conditions prevalent during any period. Even in the presence of a political uprising, companies must be protected so that they don’t cut back indefinitely.
- The policy must also be dependent on rates of inflation since this can have a long-term effect on the amount of investments. When the rate of inflation is highly variable and uncertain, the cost of investments will also be indeterminate and the policy must have provisions centered on the stability and duration of inflations usually prevalent such that low inflation rates can project a sustainable environment for foreign companies.
- The policy must also be dependent on rates of depreciation in specific sectors. When foreign investors focus on production sectors, the aim is to provide capital for technological advancements or infrastructural growth and the rate of depression on obsolete equipment will determine the extent of investments.
- The policy must also differ based on the kind of sector being invested in. While most foreign investors prefer investing in private sectors, certain invitations for investments in public sectors such as schooling, medical care and State infrastructural projects may also be made by the government.
- The policy must also specify governmental regulations such as the nature of subsidies and concessions guaranteed. While the policy may support investment costs, it must ensure that the standard of quality of these investments made are good enough to meet high rates of return, as specified.
The Components of an Investment Policy
The investment policy is drafted to provide a detailed framework of rules regulating investment portfolio decisions made by foreign investors. This is dependent on the acceptable level of risk, liquidity requirements and the restraints on investment of foreign security, and based on the extensiveness of these policies, foreign companies may even decide to opt for long term investment plans with specific goals in mind. Some of the subjects dealt with in an investment policy include[12]:
- The investment policy usually deals with the work of a portfolio manager and the responsibilities vested in one,
- The provisions for risk management,
- Establishing the roles of parties in enforcing the provisions of the policy and monitoring the outcome through effective governance
- Enumerating on the steps needed under law to review or amend such a policy, with the conditions to be considered while doing so,
- Specifying the objective of overall investment schemes,
- Outlining the possible scope of return on investment, the associated risks and the level of capital expenditure,
- Dealing with necessary restrictions on capital investments including tax considerations, legal mechanisms for review, and liquidity requirements,
- Specifying the mechanisms in place by the government for monitoring overall performance and ensuring transparent accountability on the outcome of each project, and
- Detailing the exact metrics to be used to evaluate possible performance and risk associations.
Furthermore, every policy will include[13]:
- A perambulatory statement of purpose which distinctly specifies the jurisdiction within which the rules and principles of the policy take effect. It also outlines the objective of recognizing funds that fall under the scope of an investment under this policy and thus formalizes such proposals to provide a guarantee of protected high returns. The objectives in this will depend on the liquidity of funds, the bond returns etc.
- It must also have provisions assigning roles and responsibilities related to investment decisions as representatives of the investor or State/company, including clerks and treasurers. This will provide the exact extent of authority vested in them, the qualifications required to carry out these roles, and the need for accountability to legislative bodies and procedures for internal systems to monitor their performance. This part of the policy deals with posts and offices and not individual designated persons and thus also gives procedures for appointment of new representatives when the preceding individual retires or becomes incapable.
- The policy also provides recognition to financial institutions which are used for the purpose of investments, mentions procedures of scrutinizing their working and establishes means of oversight to monitor daily functions. The criteria to designate such institutions is also mentioned, including their recent financial statements, creditworthiness and government authorization.
- The policy also specifies the kinds of investments that are eligible and the kinds of securities available to invest in.
- The policy also has a diversification strategy which determines a ceiling on the amount of capital to be invested in a particular sector or instrument. This is necessary since it prevents the flow of too much funds into just one sector, while reducing risk in the particular area.
- The policy must also specify expected standards of performance. This ensures that all investment objectives are met with each undertaking, tied to the return on investment against other economic factors.
- Finally, the policy must deal with the mechanisms of monitoring and reporting. These are internal systems that monitor the economic conditions within a particular jurisdiction and ensure that the rules of the policy and other relevant laws are complied with. This will also ensure transparency during the duration of investment and will protect investments. Usually, policies will specify that a designated officer for oversight must report to the legislative body or other authority so mentioned, every quarter. The policy may focus on an oversight committee for larger jurisdictions or may just appoint a single officer for smaller jurisdictions. It will also detail when the committee must convene to prepare a report, or how often a report is to be submitted by the officer and the kind of information that must be given in the report including present market environment, details of related transactions, changes in investment strategies etc.
A well-developed investment policy will determine to what extent investors are confident about making decisions on capital expenses, especially in case of foreign investors[14]. A good policy focuses on guidelines of transparency and security towards investors, such that the environment for large investments becomes more encouraging since investors will always examine the scope of a policy before progressing. Certain countries adopt ad-hoc policies which constantly change based on market conditions and individual decisions, while others may not consider views and opinions of specific industries when making such modifications, or where the laws and guidelines are ambiguous and not formalized, investors will see greater chances of risk with no predictable rewards, and will avoid such opportunities.
The Structure of Investment Policies of Companies
While investment policies are usually studied in the context of national trade, companies and individual investors also develop such policies through investment policy statements with the help of portfolio managers. These are important since the company or client clarifies the objectives of making investments including[15]:
- The objective of obtaining high ROI opportunities in specific sectors, and
- To reduce the extent of risk possible in such opportunities to reduce capital costs.
Further, the policy discusses plans on investments including its relations with shareholders, the possible declaration of dividends at the time of investment, the plans for reinvestment of profits of previous projects, and the final goal of internal growth of its investment portfolio[16].
The policy is also used to specify the approach towards possible investment opportunities. When the company decides to invest in a particular sector, its ideal strategy towards a flexible path to investment goals without massive risks on the ROI is explained in the policy. This will also include the kind of sector and the projects that fall under the vision of the business objectives. For a company focusing on a public sector industry, the kinds of capital commodities that would be investment targets under this classification, the exceptions to this and possible derivatives and secondary industries will be mentioned[17]. The company will also specify the types of investments including debt, royalties, and investment instruments such as future acquired income streams.
If the company is also open to transnational investment opportunities, the policy will specify the countries seen as financially feasible based on the risk-reward assessment of existing opportunities in the country and other economic conditions at the time[18]. Also, the permissible size of investments that the company is willing to make based on the extent of ownership or control being offered under each opportunity and the time period for which the company is willing to undertake investment projects is given.
Having specified the technicalities behind investment plans, the company will also specify its procedure and mechanisms for review of opportunities including the process of actively monitoring the outcome of each while they are ongoing, and the metrics to evaluate value obtained from the liquidity of investments[19].
This also includes the composition of possible committees assigned with the role of searching for and evaluating investment opportunities including identifying the extent of risks and rewards for each. This usually comprises senior management of the company, the Board of Directors and managers specifically employed for this responsibility[20]. The policy also enumerates the extent of work assigned and specifies that the evaluation of each opportunity must be based on the company’s plans and strategies, and that the committee must carry out due diligence checks and make a final decision to filter the opportunity. This may either be rejected or approved for further due diligence by appointed consultants. The committee also has to provide a brief explanation behind its decision mentioning the possible risks, the estimated ROI, the duration for such an undertaking, available mechanisms for evaluation and review, and any disclosures to be made with regards to third party fees. The policy specifies that all final approvals can only be made by the Board and a presentation of the company’s investment portfolio must be made by the committee every quarter.
Further, the policy deals with processes of negotiating the terms and conditions in an opportunity and the representatives of the company permitted to carry out the negotiation[21], the necessary compliance with relevant laws and rules of regulatory government bodies, the permissible opportunities to deviate from the guidelines and limits of the policy where additional investments could lead to large benefits, and the ways in which the company must structure these investments so that the investments made are not considered mutual funds required to be registered. If the company policies have rules regarding conflicts of interest where a member of its Board or any other officer has vested interests in an investment opportunity, the policy specifies steps to seek approval from the Board and makes it necessary to disclose such vested interests, if any after which such member is directed to refrain from casting a vote in any related investment decisions[22].
Conclusion:
Investment laws and policies need to be effective and encouraging in respect of strong regulations. Since most of these are usually directly dependent on the specific needs of investors, governments must also attempt to find a way to apply these to domestic investors without making major modifications.
An investment policy must always depend on the financial objectives of an investor, both short and long-term, and the level of risk one is usually willing to take based on the nature of volatility of the market. For this extent of consideration necessary, a well-developed framework must be adopted through investment policies which deal with the specific questions to be answered for directives and guidance.
These may relate to the existing laws and regulations governing its economy, the practices which should be aimed at protected ownership registration, the nature of IPR laws, the laws governing enforcement of contracts, the adopted modes and norms of dispute resolution, the guidelines which specify non-discriminatory practices against investors, and the extent of reviews conducted[23]. Policies which also guarantee subsidies must be implemented if the key goal is to encourage foreign investors.
[1] Acker, Olaf, Germar Schroder, and Florian Grone, “Kings of the Cloud, Strategy and Business”, 2014, Winter Edn, PricewaterhouseCoopers
[2] United Nations Monterrey Consensus on Financing for Development, 2002
[3] UNCTAD, “The Investment Policy Review Programme: A Framework for Attracting and Benefiting from FDI” www.unctad.org/ipr
[4] UNCTAD, “World Investment Report 2013: Global Value Chains – Investment and Trade for Development”, 2013, Geneva: United Nations
[5] Primarily include Asian Countries, including India
[6] International Monetary Fund, “The Role of Foreign Banks in Emerging Markets”, 2000, International Capital Markets (Washington DC: IMF)
[7] OECD paper, “Transparency and Third Party Participation in Investor State Dispute Settlement Procedures”, 2011
[8] Kanhaiya Singh, “Automotive industry: Perspectives and Strategies”, 2002
[9] Report of the Steering Group on FDI, 2002
[10] Tejvan Pettinger, “Factors Affecting Investment Polices”, 2019, https://www.economicshelp.org/blog/136672/economics/factors-affecting-investment/
[11] Marginal Efficiency of Capital
[12] CFA Institute, “Elements of an Investment Policy Statement”, 2010
[13] GFOA Best Practices, “Investment Policy and Governance Practices”, http://mrsc.org/Home/Explore-Topics/Finance/Finance-Policies/Investment-Policies.aspx
[14] Chaudhuri, “A Review of Major Debates”, 1998, p 49
[15] Radius Gold Inc., “Investment Policy – Company”, https://www.sec.gov/Archives/edgar/data/1113260/000121716015000138/radiusinvestmentpolicy.htm
[16] Mettler, Ann and Anthony D. Williams, “The Rise of the Micro-Multinational: How Freelancers and Technology-Savvy Start-Ups are Driving Growth, Jobs and Innovation”, Lisbon Council Policy Brief, Vol. 3
[17] ibid
[18] Lessons from Asia, “Handbook on Foreign Direct Investment by Small and Medium-sized Enterprises”, 1998, p 200
[19] Miller, Stewart R., Douglas Thomas, Eden, and Michael Hitt, “Knee Deep in the Big Muddy: The Survival of Emerging Market Firms in Developed Markets”, 2008, Management International Review, edn 48, p 645
[20] ibid
[21] Uruguay Business Review, “New Issues in the Uruguay Round of Multilateral Trade Negotiations,” p 52
[22] Radius Gold Inc., “Investment Policy – Company”, https://www.sec.gov/Archives/edgar/data/1113260/000121716015000138/radiusinvestmentpolicy.htm
[23] UNCTAD, “Investment Policy Framework for Sustainable Development”, 2nd ed., 2015
YLCC would like to thank Dylan Sharma for his valuable inputs in this article.
