Xerxes Antia, Aanchal Merchant and Disha Dubey
In a bid to further simplify the compliance requirements for reclassification of foreign portfolio investments (“FPI”) into foreign direct investment (“FDI”), the Reserve Bank of India (“RBI”) has recently notified a press release[1] (“Press Release”) clarifying the operational framework in this regard (“Operational Framework”).
As per the Foreign Exchange Management (Non-debt Instruments) Rules 2019, (“NDI Rules”), investments under the FPI route must be less than 10% of the total paid-up equity capital of an Indian company, on a fully diluted basis, or less than 10% of the paid-up value of each series of debentures or preference shares or share warrants issued by an Indian company[2], with the total holdings of all FPI investors investing in an Indian company, including all direct and indirect investments, not exceeding 24% of the paid-up equity capital of the Indian company, on an aggregate level[3].
With respect to any FPI that has been made by an investor (“FPI Investor”) in an Indian company, if the investments via FPI route exceeds 10% of the total paid-up equity capital of the Indian company on a fully diluted basis (“Prescribed Threshold”), then the FPI Investor has the option of either: (i) divesting its holdings; or (ii) reclassifying its FPI as FDI.
While the NDI Rules provided for such reclassification, there was ambiguity in terms of the implementation and compliance requirements for such a reclassification. The Operational Framework now provides for a detailed process as well as the compliances to be undertaken in case of such reclassification.
A brief overview of the Operational Framework is as follows:
Eligibility
Reclassification of investment made under the FPI route would not be permitted in any sector where FDI is prohibited.
Approvals/consent requirements
Before intending to acquire any equity instruments beyond the Prescribed Threshold, an FPI Investor needs to obtain:
(a) necessary approvals from the Government of India - these approvals could either be due to the investee Indian company carrying on business in any sector which falls under the government approval route under the NDI Rules or due to other factors, such as where prior government approval would be required due to the investment triggering the provisions of Press Note 3 of 2020 Series[4]; and
(b) the concurrence/consent of the Indian investee company in question for the reclassification - this is to enable the Indian company to comply with conditions concerning sectors in which FDI is prohibited or to allow the Indian company to comply with sectoral caps or obtain any government approvals required for any FDI in such Indian company.
Other important provisions to be kept in mind
Apart from obtaining any required governmental approvals and the Indian investee company concurrence as mentioned above, there are certain other conditions/provisions that would need to be complied with as part of any reclassification, namely:
(a) The FPI Investor needs to clearly articulate its intention to reclassify its FPI. Whilst the provisions of the Press Release do not clarify to whom this articulation is to be done, guidance can be taken from a circular dated November 11, 2024[5] (“SEBI Reclassification Circular”), providing for procedure for reclassification of FPI into FDI and issued by the Securities and Exchange Board of India (“SEBI”) which specifies that this intention is to be made to the applicable custodian with whom the applicable FPI Investor holds its dematerialised securities account (“Custodian”). Once the Custodian receives this intention from the applicable FPI Investor, then the Custodian will freeze the purchase transactions of the FPI Investor in the equity instruments of the applicable Indian investee company until the FPI reclassification is completed;
(b) In the event that the requisite governmental approvals or the concurrence of the Indian investee company is not obtained for the classification of the FPI into FDI within 5 trading days from the date on which the FPI investment exceeded the Prescribed Threshold, then the FPI Investor needs to compulsorily divest its FPI investment until it reaches the Prescribed Threshold;
(c) For any reclassification of FPI, there are various reporting obligations that would need to be adhered to with respect to the entire investment held by the FPI Investor in question. These reporting requirements comprise of:
(i) reporting by the Indian investee company[6] where the investment in excess of the Prescribed Threshold is due to fresh issuance of shares by the Indian company;
(ii) reporting by the FPI Investor[7] where the investment in excess of the Prescribed Threshold is due to the acquisition of equity instruments in the secondary market by the FPI investor; and
(iii) reporting by the applicable authorised dealer bank[8], who is to report the amount of reclassified FPI as divestment.
(d) Once the applicable reporting is completed, then the FPI Investor needs to approach its Custodian to transfer the FPI into a dematerialised securities account of the FPI Investor, which is maintained for the purposes of holding FDI. The Custodian is to then lift its freeze on the equity instruments held by the FPI Investor (see Paragraph 3(a) above) and transfer the equity instruments in question to the FDI dematerialised securities account;
(e) After completing the activities mentioned above, the date of the classification would be deemed to be the date on which any FPI exceeded the applicable Prescribed Threshold;
(f) Once an FPI has been reclassified as FDI, the entire investment by the FPI Investor in the Indian investee company would be classified as being FDI, even in the event that the quantum of such investment drops below the Prescribed Threshold at a later stage; and
(g) The FPI Investor along with its investor group will be treated as being a single person for the purposes of reclassification of the FPI.
SEBI Reclassification Circular
As mentioned above, SEBI has also issued the SEBI Reclassification Circular which amends the procedure for reclassification of FPI into FDI, as laid out in the Master Circular for Foreign Portfolio Investors, Designated Depository Participants and Eligible Foreign Investors dated May 30, 2024[9]. The SEBI Reclassification Circular works in tandem with the Press Release and provides more granular clarity with regard to the process laid down in the Press Release, including imposing reporting obligation on the Custodian to report the intent of reclassification (see Paragraph 3(a) above) by the FPI Investor to SEBI.
Conclusion
The regulatory changes by the RBI are intended to enhance transparency for foreign investors investing in the Indian markets via the FPI route. It details a clear mechanism and process to be followed in case a FPI Investor needs to convert its FPI into FDI, including timelines and reporting requirements. As such it is a welcome move by the RBI.
[1] Press Release No. RBI/2024-25/90 dated November 11, 2024, and issued by the RBI.
[2] Paragraph 1(a) of Schedule II of NDI Rules.
[3] Paragraph 1(a) of Schedule II of NDI Rules.
[4] Press Note 3 (2020 Series) No. DPIIT File Number 5(5)/2020 issued by the Department for Promotion of Industry and Internal Trade, Government of India, and which requires prior Indian government approval for any investments from countries sharing land borders with India or where beneficial ownership of investor is in countries sharing land borders with India.
[6] By way of Form FC-GPR.
[7] By way of Form FC-TRS.
[8] By way of LEC (FII) reporting.