RBI & SEBI roll out process for reclassification of FPI’s holding to FDI

– Vinita Nair, Senior Partner & Prapti Kanakia, Manager | corplaw@vinodkothari.com | November 15, 2024

Classification of foreign investments as Foreign Direct Investment (‘FDI’) or foreign portfolio investment is critical for determining the compliance applicable. A person resident outside India may hold foreign investment either as FDI or as foreign portfolio investment in any particular Indian company. Investments by Foreign Portfolio Investors (‘FPIs’) registered with SEBI is mainly governed by the investment restrictions and thresholds provided in SEBI (FPIs) Regulations, 2019 and Part C of SEBI Master Circular for FPIs. Pursuant to Reg. 20 (7) of SEBI regulations, a single FPI (including its investor group^[1]) can invest upto 10% of the total paid- up equity capital on a fully diluted basis of the company. In case of breach of this threshold, the FPIs get 5 trading days from the date of settlement of the trades resulting in the breach to correct the position, in terms of the SEBI Regulations as well as Rule 10(1) of FEM (Non-Debt Instruments) Rules, 2019 (‘NDI Rules’), failing which the entire investment is considered as FDI and procedure prescribed by SEBI in Para 17 of Part C of the SEBI Master Circular is required to be followed i.e.:

• Follow extant FEMA rules & RBI prescribed norms in this regard;
• No further foreign portfolio investment in that company;
• FPI to inform respective custodians of the choice who in turn will report this to SEBI, depositories and the issuer;
• Sale of these securities permitted only through the route they were acquired & LEC reporting by custodian.

Present Circulars

Effective from November 11, 2024 SEBI has amended the procedure provided in Para 17 above to the following effect:

• FPI to follow extant FEMA rules and circulars;
• Custodian to report to SEBI upon receipt of the intent from FPI;
• Custodian to freeze purchase transactions in equity instruments of such Indian company, till completion of re-classification;
• Custodian to process the transfer from FPI demat a/c to the demat a/c maintained for holding FDI investments only after completion of reporting of the reclassification in the manner prescribed by RBI.

Further, RBI has provided the operational framework discussed in detail below.

Pre-requisities for Reclassification

Fig. I – Pre-requisites for re-classification

• Investment should not be in a sector that is prohibited for FDI^[2] since FPIs are allowed to invest in Indian companies operating in a prohibited sector upto an aggregate limit of 24%.
• Necessary government approvals are obtained:
  • Press Note 3 – In case of investment by an entity of a country which shares land border with India or where the beneficial owner of an investment into India is situated in or is a citizen of any such country, government approval shall be obtained.
  • Entry route – In case of investment falling under approval route.
• Investment to be in compliance with following conditions:
  • Sectoral cap as provided in Schedule I to NDI Rules;
  • Pricing guidelines as per Rule 21 of NDI Rules;
    • Listed company – pricing as per SEBI guidelines
      • Listed company opting for delisting – pricing as per SEBI (Delisting of Equity Shares) Regulations, 2009;
    • Unlisted Indian company – Valuation as per internationally accepted pricing methodology duly certified by a Chartered Accountant or a Merchant Banker or a practising Cost Accountant; and
  • Other attendant conditions for FDI as specified in Schedule I.
• Concurrence of Indian investee Company for reclassifying the investment as FDI

Process of reclassification

Fig. II – Process of re-classification

^[1] FPIs directly or indirectly, having common ownership of more than 50% or common control.

^[2] (a) Lottery Business including Government/ private lottery, online lotteries, (b) Gambling and betting including casinos, (c) Chit funds, (d) Nidhi company, (e) Trading in Transferable Development Rights (TDRs), (f) Real Estate Business or Construction of farm houses, (g) Manufacturing of Cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes (h) Activities/sectors not open to private sector investment viz., (i) Atomic energy and (ii) Railway operations (i) Foreign technology collaboration in any form including licensing for franchise, trademark, brand name, management contract is also prohibited for lottery business and gambling and betting activities.

Our Resources on the topic:-

1. FPIs with single corporate group concentration to disclose beneficial ownership
2. Familiar with FEMA (YouTube series)
3. FPIs – Synoptic Overview
4. Investment window for FPIs widened
5. Introduction to FEMA & FEMA (NDI) Rules, 2019