
On November 11, 2024, the Reserve Bank of India (“RBI“), notified an operational framework for reclassification of Foreign Portfolio Investment (“FPI“) to Foreign Direct Investment (“FDI“)1, once it exceeds the threshold percentage of 10% (ten percent) of the total paid-up equity capital (on a fully diluted basis) of an Indian company.
Schedule II of the NDI Rules:
Schedule II of the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“NDI Rules“) prescribes that while a foreign portfolio investor (“Investor“) can purchase equity of an Indian company listed or to be listed on a recognised stock exchange, the total holding by each Investor and its investment group should be less than 10% (ten percent) of the total paid-up equity capital on a fully diluted basis.
In case the investment amount crosses 10% (ten percent), then the Investor has the option to divest their holdings within 5 (five) trading days from the date of settlement of the trades causing the breach. If the Investor chooses not to divest their holdings, then the entire investment in the company by the Investor and their investment group shall be considered as an investment under the FDI, and the Investor and their investment group will be prohibited from making any further portfolio investment in the concerned company.
Operational Framework for Reclassification of FPI into FDI:
In case the Investor intends to reclassify the FPI into FDI, the Investor will be required to adhere to the following operational framework:
- Prohibition: The option to reclassify FPI into FDI is not permitted in the sectors which are prohibited under the FDI such as lottery business, chit fund, Nidhi companies, real estate etc.
- Approvals and Concurrence: Investor shall obtain following approvals and concurrence before acquiring equity capital beyond the prescribed limit:
a. Necessary approval from the Government of India, as applicable, including approvals required in case of investment from land bordering countries. Additionally, the acquisition beyond the prescribed limit should adhere to the entry route, sectoral caps, investment limits, pricing guidelines and other conditions prescribed under Schedule I of the NDI Rules.
b. The Investor shall concur with the investee company for reclassification of FPI into FDI to enable such company to ensure compliance with the NDI Rules.
- Investor’s Intent and Custodian’s Duty: The Investor shall clearly communicate its intent to reclassify the FPI into FDI and shall provide necessary approvals and concurrence to the custodian pursuant to which the custodian shall freeze the purchase transactions by such Investor in equity instruments of the concerned company, till the completion of the reclassification process. In case the Investor fails to obtain necessary approvals and concurrence, the investment beyond the prescribed limit shall be compulsorily divested within the prescribed time limit.
- Reporting Requirement: In case of reclassification of FPI into FDI, the entire investment held by the Investor shall be reported within the timelines specified under Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019 in the following manner:
a. In case the investment beyond the prescribed limit results from fresh issuance of equity shares by the company to the Investor, such company will be required to file Form FC-GPR within 30 (thirty) days from the date of issuance of equity instruments.
b. In case the investment beyond the prescribed limit results from the acquisition of equity instrument by the Investor from the secondary market, the Investor is required to file Form FC-TRS within 60 (sixty) days of transfer of equity instruments or remittance of funds, whichever is earlier.
c. The concerned Authorized Dealer Bank will be required to file Form LEC (FII) to report the amount of reclassified FPI as divestment.
- Treatment of FPI post reclassification: Once all the reporting is done by all the concerned parties, the Investor shall approach the custodian requesting transfer of the equity instruments of the company from its demat account maintained to hold FPI to its demat account maintained to hold FDI. The custodian, after ensuring that the reclassification is complete as per the operational framework, will unfreeze the equity instruments and process the request. Once the process of reclassification is completed, the entire investment of the Investor in the concerned company will be treated as FDI, even if the investment falls below the prescribed limit of 10% (ten percent) subsequently. For the purpose of reclassification of FPI into FDI, the Investor along with its investor group will be treated as a single person.
- Once the FPI is reclassified as FDI, the said investment will be governed by Schedule I of the NDI Rules which pertains to ‘Purchase or sale of equity instruments of an Indian company by a person resident outside India’.
Analysis:
The operational framework notified by the RBI was a much-needed step in streamlining the entire process of reclassification of FPI into FDI. While the NDI Rules were silent on the compliance and procedure for reclassification, the operational framework has brought much clarity by setting out clear steps for reclassifying FPI into FDI. It has provided much-needed guidance to ensure compliance with the NDI Rules while investing in Indian companies.
1Available at: https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12749&Mode=0.