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Operational framework for reclassification of Foreign Portfolio Investment to Foreign Direct Investment (FDI)

Reserve Bank of India (RBI) has released operational framework for reclassification of Foreign Portfolio Investment to Foreign Direct Investment (FDI).

What is Foreign Portfolio Investment?

Foreign portfolio investment means any investment made by a person resident outside India through equity instruments where such investment is less than 10% of the post issue paid-up share capital on a fully diluted basis of a listed Indian company or less than 10% of the paid-up value of each series of equity instrument of a listed Indian company. 

Fully diluted basis means the total number of shares that would be outstanding if all possible sources of conversion are exercised.

Foreign Portfolio Investor (FPI) means a person registered in accordance with the provisions of the Securities and Exchange Board of India (Foreign Portfolio Investors) Regulations, 2014.

What is Foreign Direct Investment (FDI)?

Foreign Direct Investment (FDI) means investment through equity instruments by a person resident outside India in an unlisted Indian company; or in 10% or more of the post issue paid-up equity capital on a fully diluted basis of a listed Indian company.

In case an existing investment by a person resident outside India in equity instruments of a listed Indian company falls to a level below 10%, of the post issue paid-up equity capital on a fully diluted basis, the investment shall continue to be treated as FDI.

What are the rules for purchase or sale of equity instruments by FPIs?

FPI may purchase or sell equity instruments of an Indian company listed or to be listed on a recognised stock exchange in India subject to the following conditions –

  • The total holding by each FPI or an investor group, shall be less than 10% (called individual limit) of the total paid-up equity capital on a fully diluted basis or paid-up value of each series of debentures or preference shares or share warrants issued by an Indian company.
  • The total holdings of all FPIs put together, including any other direct and indirect foreign investments in the Indian company, shall not exceed 24% (called aggregate limit) of paid-up equity capital on a fully diluted basis or paid up value of each series of debentures or preference shares or share warrants.
  • With effect from April 1, 2020, the aggregate limit shall be the sectoral caps applicable to the Indian company as per Schedule I of Foreign Exchange Management (Non-debt Instruments) Rules, 2019. The aggregate limit with respect to an Indian company in a sector where FDI is prohibited shall be 24%.

What if foreign portfolio investment exceeds the prescribed limit?

  • The FPIs investing in breach of the prescribed limit shall have the option of divesting their holdings within 5 trading days from the date of settlement of the trades causing the breach. 
  • In case the FPI chooses not to divest, then the entire investment in the company by such FPI and its investor group shall be considered as investment under FDI and the FPI and its investor group shall not make further portfolio investment in the company concerned. 
  • The FPI, through its designated custodian, shall bring the same to the notice of the depositories as well as the concerned company for effecting necessary changes in their records, within 7 trading days from the date of settlement of the trades causing the breach. 

What is the operational framework of RBI for reclassification of investments by FPIs to FDI?

In case the FPI intends to reclassify its foreign portfolio investment into FDI, the FPI shall follow the operational framework as given below –

  • The facility of reclassification shall not be permitted in any sector prohibited for FDI.
  • The FPI concerned shall obtain the following approvals / concurrence –
    • Necessary approvals from the Government and ensure that the acquisition beyond prescribed limit is in accordance with the FDI rules.
    • Concurrence of the Indian investee company concerned for reclassification of the investment to FDI to enable such company to ensure compliance with FDI rules.
  • FPI shall provide the copy of the necessary approvals and concurrence to its Custodian pursuant to which the Custodian shall freeze the purchase transactions by such FPI in equity instruments of such Indian company, till completion of the reclassification.
  • Where the necessary prior approvals / concurrence have not been obtained by the FPI, the investment beyond the prescribed limit shall be compulsorily divested within the prescribed time.
  • For reclassification, the entire investment held by such FPI shall be reported within the timelines as specified under Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019, in the following manner –
    • By the Indian company in form FC-GPR where the investment beyond the prescribed limit is resulting from fresh issuance of equity instruments by an Indian company to such FPI.
    • By the FPI in form FC-TRS, where the investment beyond the prescribed limit is due to acquisition of equity instruments by such FPI in the secondary market.
    • AD bank concerned shall report the amount of reclassified foreign portfolio investment as divestment under the LEC (FII) reporting.
  • Post completion of reporting as above, the FPI shall approach its Custodian with a request for transferring the equity instruments of the Indian company from its demat account maintained for holding foreign portfolio investments to its demat account maintained for holding FDI. After ensuring that the reporting for reclassification is complete in all aspects, the custodian shall unfreeze the equity instruments and process the request. 
  • The date of investment causing breach shall be considered as the date of reclassification. 
  • The entire investment of the FPI in the Indian company shall be considered as FDI and shall continue to be treated as FDI even if the investment falls to a level below 10% subsequently. 
  • FPI along with its investor group shall be treated as a single person for the purpose of reclassification of foreign portfolio investment.
  • Post reclassification of foreign portfolio investment to FDI, the said investment shall be governed by Schedule I to Foreign Exchange Management (Non-debt Instruments) Rules, 2019.

What are other rules for investments by FPIs?

  • FPI may, undertake short selling as well as lending and borrowing of securities.
  • FPI may purchase units of domestic mutual funds or Category III Alternative Investment Fund or offshore fund for which no objection is issued in accordance with the SEBI (Mutual Fund) Regulations, 1996, which in turn invest more than 50% in equity instruments on repatriation basis.
  • FPI may purchase units of REITs and InVITs on repatriation basis.


References

Government of India. (2019, October 17). 'Foreign Exchange Management (Non-debt Instruments) Rules, 2019'. Retrieved from https://enforcementdirectorate.gov.in/sites/default/files/Act%26rules/Foreign%20Exchange%20Management%20%28Non-Debt%20Instrument%29%20Rules%2C%202019%20-%20without%20amendment_2.pdf

Reserve Bank of India. (2024, November 11). 'Operational framework for reclassification of Foreign Portfolio Investment to Foreign Direct Investment (FDI)'. Retrieved from https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12749&Mode=0

Reserve Bank of India. (2024, November 11). 'Operational framework for reclassification of Foreign Portfolio Investment to Foreign Direct Investment (FDI) under Foreign Exchange Management (Non-debt Instruments) Rules, 2019'. Retrieved from https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=59073


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