RBI amends FEMA norms to promote usage of INR in global markets

February 03, 2025

-Prapti Kanakia, Manager & Anjali Singh, Executive | corplaw@vinodkothari.com

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FEMA facilitates acquisition of foreign entity by Indian companies through cross border swaps

RBI revamps Master Directions on Compounding under FEMA

Powers of RBI Officers enhanced for compounding FEMA offences

Union Budget 2025: Key Highlights and Reforms focusing on Financial Sector Entities

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Downstream investment to be treated at par with FDIs

Introduction

The Master Direction on Foreign Investment in India, recently updated on January 20, 2025, goes beyond a mere consolidation of the recent amendments in the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (‘NDI Rules’), providing clarifications in several areas of legislative silence.  One of the key  areas of clarification include the rules around downstream investments. 

In this note, we have discussed downstream investment through stock deals and other significant clarifications provided in the Master Direction.

Background

Rule 6(a) of the NDI Rules deals with the investment by a person resident outside India (‘PROI’) in the equity instruments of an Indian company. The said rule refers to Schedule I, which, amongst others, specifies the modes of payment of consideration. Prior to the FEM (Non-Debt Instruments) (Fourth Amendment), Rules, 2024 dated August 16, 2024 (“Fourth Amendment Rules”), the Schedule contained an enabling provision for Indian companies to issue its equity instruments to PROI  by way of swap of equity instruments. Since the term “equity instruments”, as defined under Rule 2(k) of Principal NDI Rules, means equity shares, convertible debentures, preference shares and share warrants issued by an Indian company, the provision permitting share swaps was read narrowly to refer to swap of shares of an Indian company against that of another Indian company only. 

However, pursuant to the Fourth Amendment Rules, the Schedule was further amended to expressly provide for the swap of equity capital, as defined under rule 2(1)(e) of  Foreign Exchange Management (Overseas Investment) Rules, 2022. The same is defined as “equity shares or perpetual capital or instruments that are irredeemable or contribution to non-debt capital of a foreign entity in the nature of fully and compulsorily convertible instruments.”

Downstream investment, on the other hand, is governed by the provisions of Rule 23 of the NDI Rules. While the said rule specified certain requirements to be complied with in the context of downstream investment, including the sources through which funds can be brought in for the purpose of such investments, the rule neither explicitly provided for the share swaps as a permitted mode of payment, nor contained any reference to Schedule I of the NDI Rules. As a result there was uncertainty among industry stakeholders on permissibility of share swaps as a form of consideration in case of downstream investment.  

Meaning of Downstream Investment

The explanation to Rule 23 (also contained in Para 9.1.13 of the Master Direction) states that: 

Downstream Investment is an investment made by an Indian entity which has received foreign investment or an Investment Vehicle in the equity instruments or the capital, as the case may be, of another Indian entity.

In other words, when an Indian entity owned or controlled by PROI [commonly referred to as a Foreign Owned and Controlled Entity (FOCC)] makes investments in the equity instruments/ capital of an Indian entity, such an investment will be considered as downstream investment for the PROI. Such arrangements enable PROI to hold investment in other Indian entities indirectly, thus, considered as an indirect foreign investment. As a result, the restrictions, prohibitions and limitations as applicable to direct foreign investments will be applicable at the time of downstream investment as well. For better understanding, refer to the figure below:

Guiding principle on downstream investment: what cannot be done directly, shall not be done indirectly

The recent updates in the Master Directions provide for the guiding principles of downstream investments, thereby clarifying that all permissions  and prohibitions vis-à-vis  direct foreign investment under the NDI Rules will be applicable to indirect foreign investment (i.e. downstream investment) as well. 

Para 9 of the Recent Master Direction reads as below: 

“The guiding principle of the downstream investment guidelines is that “what cannot be done directly, shall not be done indirectly”. Accordingly, downstream investments which are treated as indirect foreign investment are subject to the entry routes, sectoral caps or the investment limits, as the case may be, pricing guidelines, and the attendant conditionalities for such investment as laid down in the NDI Rules.”

Giving reference to above guiding principles, the Master Directions explicitly refers to the permissibility of the arrangements which are available for direct investment such as investment by way of swap of equity instruments/equity capital, payment arrangements/mechanism as per Rule 9(6) of the Rules etc, for the purpose of downstream investment as well.

Implication of above clarification

The above clarification has paved a way for Foreign Owned or Controlled entities (FOCC) to make further investments in Indian entities by way of swapping equity capital of foreign companies held by it in addition to other sources as already available. This arrangement of swapping of securities is known as a stock deal. 

Previously, for making downstream investment, an FOCC was  allowed to raise fresh funds from abroad by way of issue of securities including non-convertible debentures or by utilising internal accruals such as profits after tax. For more clarity refer to the table below:

Sources of making investment by FOCC in another Indian entityPosition prior to the clarification After clarification
Internal accruals (i.e., profits transferred to reserve account after payment of taxes)Allowed Allowed
Fresh funds from abroad including issue of NCDAllowed Allowed
Swap of equity instruments/ capital No express provision Allowed
Using funds borrowed in the domestic marketsNot allowed Not allowed

Other conditions w.r.t downstream investment in light of the guiding principle

As per the guiding principle on downstream investments as discussed above, an Indian entity which has received indirect foreign investment is subject to  permissions and prohibitions as applicable to direct foreign investment under NDI Rules. Further, the onus of ensuring such compliances are on the FOCC making such investments, and not on the Indian investee entity receiving such indirect FDI. 

  1. Investment from land border sharing countries 

In order to curb opportunistic takeovers/ acquisitions of Indian companies due to COVID-19 pandemic, the Government of India restricted investment from countries sharing land borders with India or where the beneficial owner of an investment into India is situated in or is a citizen of any such country, by way of issue of Press Note-3. As a result, any foreign direct investment from such countries would be permitted with prior approval of the Government of India in permissible sectors. 

This will be applicable in case of investment by FOCC as well, where such FOCC, in turn, has received investment from such countries as discussed above. 

  1. Deferred payment arrangements

Similarly, the facility of making deferred payment of up to 25%  in case of transfer of equity instruments between PROI and Person Resident in India (PRI) will also be applicable in case of downstream investment. This is, subject to the compliance with the conditions as laid down in Rule 9(6) of the NDI Rules. 

The Master Directions further state that a transaction intended to be undertaken using above arrangement(s) shall require the share purchase/transfer agreement to contain the respective clause and related conditions for such arrangement.

  1. Subsequent classification as downstream investment

Where  an Indian entity (i.e., investor) at the time of making further investment in another Indian entity (i.e., investee) was not an FOCC at the time of investment, but subsequently becomes an FOCC, then such investment in another Indian entity would need to be reclassified as downstream investment from the date when investor entity becomes FOCC. Consequently, such downstream investment shall be in compliance with the applicable entry route and sectoral cap compliances and shall be required to be reported by the investor entity within 30 days from the date of such reclassification in form DI.

  1. Valuation requirement 

As per para 8.4 of the Recent Master Direction, in case of swap of equity instruments, irrespective of the amount, valuation will have to be made by a Merchant Banker registered with SEBI or an Investment Banker outside India registered with the appropriate regulatory authority in the host country.

  1. Downstream Investment by NRI/OCI on non-repat. basis to be treated as domestic investment 

The investments made by NRIs/OCIs on non-repatriation basis is treated as deemed domestic investment. Accordingly, an investment made by an Indian entity which is owned and controlled by a Non-Resident Indian or an Overseas Citizen of India including a company, a trust and a partnership firm incorporated outside India and owned and controlled by a Non-Resident Indian or an Overseas Citizen of India, on a non-repatriation basis in compliance with Schedule IV of these rules, shall not be considered for calculation of indirect foreign investment.

To know more about foreign investment, check out our YouTube repository on:

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.
Read more

Powers of RBI Officers enhanced for compounding FEMA offences

– Prapti Kanakia, Manager | Corplaw@vinodkothari.com

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  1. FEMA facilitates acquisition of foreign entity by Indian companies through cross border swaps
  2. Single Corporate Group focused FPIs & Large value FPIs to disclose granular details of beneficial ownership

IFSC Gateway to Global Access for Indian unlisted companies

– Prapti Kanakia, Manager & Simrat Singh, Executive | Corplaw@vinodkothari.com

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FEMA facilitates acquisition of foreign entity by Indian companies through cross border swaps

Vinita Nair and Prapti Kanakia l corplaw@vinodkothari.com

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Trust, but verify: AIFs cannot be used as regulatory arbitrage

SEBI mandates ongoing due diligence for investors and investments made by AIFs

-Vinita Nair, Senior Partner and Lavanya Tandon, Executive | corplaw@vinodkothari.com

May 03, 2024 (updated on October 9, 2024)

Background

SEBI had raised concerns relating to evergreening of loans, circumvention of FEMA norms, QIB regulations and other concerns on regulatory arbitrage by Alternative Investment Funds (‘AIFs’) in its Consultation Paper issued in January, 2024. SEBI also recorded 40+ cases wherein the structure of AIF had been abused and used to circumvent extant financial sector regulations. Read our analysis in the article ‘AIFs ail SEBI: Cannot be used for regulatory breach’ dated January 31, 2024. Further, RBI had also barred all regulated entities (REs) with respect to their investments in AIFs, discussed in our article.

Subsequent to receipt of public comments, the proposal to mandate due-diligence (‘DD’) of investors and each of the investments made by the AIF was approved in the SEBI Board meeting held on March 15, 2024. SEBI notified SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2024 effective from April 25, 2024 amending Reg. 20 of the SEBI (Alternative Investment Funds) Regulations, 2012 (‘AIF Regulations’) dealing with general obligations thereby requiring every a. AIF, b. investment manager of the AIF, c. KMP of the AIF, and d. KMP of the investment manager, to exercise specific DD with respect to their investors and investments in order to prevent facilitation of circumvention of such laws as may be specified by SEBI from time to time. 

The list of laws, thresholds and conditions for DD, reporting requirements etc. has been provided in  SEBI circular dated Oct 8, 2024 (‘SEBI Circular’). DD is required to be carried out prior to making of investments as per implementation standards formulated by Standard Setting Forum for AIFs (‘SFA’)  and published on websites of the industry associations which are part of the SFA, i.e., Indian Venture  and  Alternate  Capital  Association (‘IVCA’), PE VC CFO Association and Trustee Association of India. 

Scope of laws covered under the ambit of due diligence

The list of laws provided in the SEBI Circular comprises of the following: 

  • Provisions of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (‘ICDR Regulations’), and other regulations of SEBI wherein benefits or relaxations have been provided to entities designated as Qualified Institutional Buyers (‘QIBs’).
  • Provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (‘SARFAESI Act’) wherein benefits are provided to entities designated as Qualified Buyers (‘QBs’).
  • Prudential norms specified by RBI for regulated lenders with respect to Income Recognition, Asset Classification, Provisioning and restructuring of stressed assets;
  • Rule 6 of FEMA (Non-Debt Instruments) Rules, 2019 (NDI Rules) for investment from countries sharing land border with India ( read with Press Note 3 dated April 17, 2020 of FDI Policy 2020)

Timing, thresholds for DD, reporting requirements

Pursuant to the SEBI Circular, the due diligence for various investors and investments is required to be carried out by a. AIF, b. investment manager of the AIF, c. KMP of the AIF, and d. KMP of the investment manager in accordance with the Implementation Standards. The table below indicates in brief the criteria, checkpoints and timelines for conducting due diligence along with the consequences of the outcome. 

Sr. NoObjective intended to be achieved by investors  through investments in AIF schemeRegulations/ Directions/ Norms applicableApplicability of requirement of DD for every scheme of AIF (refer Note 1)Checkpoints for manager for specific DD Timing of DD Consequence of outcome of DD & reporting requirements, if any
1Benefits designated for QIBs ICDR and other SEBI RegulationsIf an investor, or investors belonging  to the same group, contribute(s)50% or more to the corpus of the scheme.Manager to check if such if investor/ investors of the same group is/are:(i) QIBs themselves or,(ii) Entities established, owned or controlled by the Central Government or a State Government or the Government of a foreign country, including central banks and sovereign wealth funds.Note: Where such investor is an AIF or fund set up in IFSC or outside India, above check to be carried out on a look through basis.Prior to availing benefits available to QIBs 
Refer Note 2 below for existing investments & Note 3 for proposed investments.Manager to provide confirmation to SE or lead manager or merchant banker on this.
2Benefits designated for QBsUnder SARFAESI ActIf an investor, or investors belonging  to the same group, contribute(s)50% or more to the corpus of the scheme.Same as abovePrior to making any investments or availing benefits Refer Note 2 below for existing investments & Note 3 for proposed investments.
3RBI regulated lenders/ entities ever-greening their stressed loans/ assets & circumventing RBI normsRBI norms on Income    Recognition,    Asset    Classification, Provisioning and Restructuring of stressed loans/ assets(a)whose manager or sponsor is an entity regulated by RBI; or,(b)that has investor(s)regulated by RBI who:(i)individually or   along   with   investors   of the same   group contribute(s) 25% or more to the corpus of the scheme; or(ii) is an associate of the manager/ sponsor of the AIF;(iii) has majority or veto power [by itself, or through its representatives/ nominees] in voting over  decisions of the investment  committee  set up  by   the manager to approve investment decisions of the scheme.Note: where investor is an AIF or fund set up in IFSC or outside India, criteria check to be carried out on a look through basis.Refer Note 4.Prior to making any investments, to avoid indirect investment by RBI regulated lender/ entity.Refer Note 2 below for existing investments & Note 3 for proposed investments.
4Investment from countries sharing land border with IndiaFEMA (NDI) Rules, 2019Where 50% or more of the corpus of the scheme is contributed by investors (a)who are citizens of/are from/are situated in a country which shares land border with India; or(b)whose beneficial owners, as determined  in  terms  of  Rule  9 (3)  of  the  PMLA (Maintenance  of Records)  Rules,  2005, are citizens  of/are from/are situated in a country which shares a land border with India.If the proposed investment would result in the scheme holding           10 % or more of equity/equity-linked securities issued by the company (on a fully-diluted basis), the manager to check details stated in the previous column, by collecting information on the country of investors and their beneficial owners.Prior to making any investmentRefer Note 2 below for existing investments & Note 5 for proposed investments.

Note 1: same group’ shall mean ‘related parties’  and  ‘relatives’ as  defined  in  SEBI  (Listing  Obligations  and  Disclosure Requirements) Regulations, 2015.

Note 2

For Sr nos 1 to 3: DD requirement is applicable for existing investments too, held by AIF schemes as on October 8, 2024:

  • If DD check not satisfactory – details of investment to be reported to AIF’s custodian on or before April 07, 2025, in the format as per Annexure 1 of the circular;
  • If DD check satisfactory – AIF manager to submit an undertaking to AIF’s custodian on or before April 07, 2025.

For Sr no. 4: Reporting is required to be made for existing investments held by AIF schemes as on October 8, 2024 if the scheme holds 10% or more of equity/ equity-linked securities on a fully-diluted basis,  to AIF’s custodian on or before April 07, 2025 in the format prescribed by SFA.

Note 3

Consequence of not satisfying requirements of DD checks specified by SFA for proposed investments in case of Sr nos 1 to 3:

  • Such investor or investor group to be excluded along with necessary disclosure in the private placement memorandum (PPM); or 
  • Investment cannot be made.

Note 4: 

Note 5: Details of investment, which would result in the scheme holding 10% or more of equity/ equity-linked securities on a fully-diluted basis, to be reported to the custodian within 30 days of investment, in the below format specified by SFA.

DD requirement – one-time or ongoing?

As discussed in the SEBI BM Agenda, the  purpose  of  the  due-diligence  check  is  to  prevent  facilitation of any circumvention of provisions of financial sector regulators, which cannot be a time specific check. An entity who intends to circumvent can design the structure in such a way that, at a later date post investment, it acquires the units  of  AIFs  post  investment,  such  as  buying  the  units  of  an  existing investor or by acquiring control over the existing investor entity, as per prior arrangement.  Accordingly, it has been indicated that due diligence around investors and investments will be an ongoing one.

Applicability of DD – prospective or retrospective?

As per the SEBI circular this is applicable for existing and prospective investments. Refer Note 2 above.

Obligations of Custodian to the AIF

  • Information received from AIFs under Note 2 to be furnished to SEBI on or before May 7, 2025.
  • Information received from AIFs in terms of Note 4 above on a monthly basis to be compiled and reported to SEBI within 10 working days from month end.

Power of AIF to exclude an investor

As per SEBI Circular, in cases where the outcome of DD is not satisfactory, in that case the AIF will either have to exclude the investor or investor group or abstain from making the proposed investment. 

Dealing with power to exclude an investor, in April  2023 SEBI had issued ‘Guidelines with respect to excusing or excluding an investor from an investment of AIF that empowered an AIF to excuse its investor from participating in a particular investment in the following circumstances:

Figure 1: Circumstances to excuse an investor of AIF

Conclusion

The present amendment and SEBI Circular lays an onerous burden on the AIF, manager and KMP of the AIF and the manager. The DD requirement has become effective from October 8, 2024 and applies to existing investments as well. The AIFs have an actionable of evaluating the existing investments in the scheme in the light of the present amendment and ensure reporting in next 6 months. The obligation of on-going due diligence will result in a compliance burden, but is justified given the intent of law as “quando aliquid prohibetur ex directo, prohibetur et per obliquum” i.e. things that cannot be done directly should not be done indirectly either. AIFs will continue ‘trust, but verify’ using the DD standards for due diligence. The trustee/ sponsor of the AIF is required to ensure that compliance status of this amendment is reported to SEBI in the ‘Compliance Test Report’ prepared by the manager in terms of Chapter 15 of Master Circular for AIFs.

Our other resources:

  1. FAQs on Specific Due Diligence of investors & investments of AIFs
  2. AIFs ail SEBI: Cannot be used for regulatory breach
  3. RBI bars lenders’ investments in AIFs investing in their borrowers
  4. Some relief in RBI stance on lenders’ round tripping investments in AIFs

LEAP to listing: India permits direct listing of shares overseas through IFSC

MCA & MOF notify rules for the same

– Vinita Nair & Prapti Kanakia | corplaw@vinodkothari.com

January 25, 2024 (Updated on August 31, 2024)

Indian companies were permitted to raise funds from overseas either pursuant to issue of depository receipts listed overseas or having the non-residents subscribe to issuances made in India or by way of borrowing overseas. As an initiative to provide an avenue to access global capital markets, GoI had announced the decision to ease the raising of foreign funds in order to boost foreign investment inflows, unlock growth opportunities, and offer flexibility to Indian companies to raise funds. Consequently, an enabling provision for direct listing of prescribed class of securities on permitted stock exchanges in permissible foreign jurisdictions was inserted vide Companies (Amendment) Act, 2020 in Section 23 of Companies Act, 2013 (‘CA, 2013’), that deals with permissible modes of issue of securities, vide notification dated September 28, 2020, and made effective from October 30, 2023. Thereafter, the Ministry of Corporate Affairs (‘MCA’) notified Companies (Listing of equity shares in permissible jurisdictions) Rules, 2024 (‘LEAP Rules’) effective from January 24, 2024. As listing of shares abroad will result in raising funds from Persons Resident Outside India (PROI), Ministry of Finance (‘MoF’) notified FEMA (Non-Debt Instruments) Amendment Rules, 2024 amending FEMA (Non-Debt Instruments) Rules, 2019 (‘NDI Rules’) with effect from January 24, 2024. SEBI is also expected to roll out the operational guidelines for listed companies to list their equity shares on permitted stock exchanges.[1]

Additionally, FAQs on direct listing scheme (FAQs) have also been rolled out on January 24, 2024. Further, two of the key recommendations of the working group report on Direct Listing of Listed Indian Companies on IFSC Exchanges submitted in December 2023 were to notify the rules under Section 23 (3) and (4) of CA, 2013 and notify necessary amendments in NDI Rules to permit cross-jurisdiction issuance and trading of equity shares of Indian companies on IFSC exchanges.

Presently, both the LEAP Rules as well as NDI Rules have notified International Financial Services Centre in India (‘Gift City’) as the permissible jurisdiction and India International Exchange and NSE International Exchange (‘IFSC Exchanges’) as the permissible stock exchange. International Financial Services Centres Authority (‘IFSCA’) had issued the IFSCA (Listing) Regulations, 2024 effective August 29, 2024 (‘IFSC Regulations’) however, in the absence of enabling provision under CA, 2013 and NDI Rules, Indian companies were unable to undertake listing of securities abroad.

In this article we provide an overview of the regulatory regime and deal with the procedural aspect.

Regulatory regime for listing securities in IFSC

Chapter X of the NDI Rules permits investment by a permissible holder subject to conditions specified in Schedule XI. Schedule XI inter-alia provides the permissible mode of issuance, eligibility conditions for a permissible holder and Indian companies, obligations of the companies and requirements relating to voting rights and pricing.

LEAP Rules prescribe the eligibility norms for unlisted public companies and procedural aspects in relation to timeline and form for filing the prospectus, complying with Indian Accounting Standards post listing etc.

The IFSC Regulations provide the general conditions w.r.t the principles and eligibility criteria for issuer, specific eligibility criteria for IPO, procedural requirements in case of an entity freshly listing on IFSC exchanges (Chapters I, II, III) and also norms for secondary listing of specified securities (Chapter V). Chapter VI deals with listing of special purpose acquisition companies (SPAC).  Comparison of the requirements under IFSC Regulations vis-a-vis under ICDR Regulations is enclosed as Annexure 1.

Mode of Listing

Companies can raise the funds either by issuing fresh capital or by offering the existing shares. In the latter case, the existing shareholders tender their shares. Both the methods are allowed under LEAP Rules & NDI Rules for listing the equity shares on IFSCA exchanges.

Figure 2: Mode of listing

Para 2 of Schedule I to NDI Rules prohibits certain sectors for investment, meaning the company engaged in prohibited sector is not allowed to raise foreign funds[2]. The same conditions are applicable in case of listing in IFSC either by way of fresh issuance/offer for sale. Eg. Nidhi company is a prohibited sector and therefore the nidhi company cannot list its equity share in IFSC.

Further, Schedule I to NDI Rules prescribes sectoral caps which are required to be complied by the public Indian company at the time of direct listing. Refer Cap on Foreign Funds for further details.

Companies ineligible to list in IFSC

NDI Rules, LEAP Rules, and IFSC Regulations provide certain eligibility criteria for companies intending to list the specified securities on permissible stock exchanges. The same are discussed below:

Companies ineligible under LEAP Rules

LEAP Rules are applicable to both unlisted public companies and listed public companies, however, the eligibility criteria under LEAP Rules are applicable to unlisted public companies only. Rule 5 of LEAP Rules provides that the following companies shall not be eligible for listing the equity shares in IFSC;

Figure 3: Companies ineligible under LEAP Rules

Companies ineligible under NDI Rules

Para 3 of Schedule XI to NDI Rules provides the eligibility criteria for direct listing. Para 3(1) & 3(3) is applicable to unlisted public companies and para 3(1) & 3(2) is applicable to listed companies. The eligibility conditions are based on the type of issuance i.e. fresh issuance or offer for sale.

In case of fresh issuance, the following companies are ineligible:

Figure 4: Companies ineligible under NDI Rules, in case of fresh issuance

Most of the conditions above are similar to those provided in Reg. 5, 61, 102, etc. of SEBI (ICDR) Regulations, 2018 (‘ICDR Regulations’) except for the ineligibility arising on account of inspection or investigation under CA, 2013. Chapter XIV of CA, 2013 deals with the requirements relating to inspection, inquiry, and investigation. The Registrar of Companies is empowered to carry out inspection in terms of Section 206 of CA, 2013 and on the basis of the outcome of the same or for other reasons specified in Section 210, the Central Government may order an investigation. In case of inspection or investigation, it is likely that the same may continue for a longer period without any tangible outcome. In such cases, this restriction will act as a deterrent for the companies eligible otherwise. Additionally, reg. 5 (2) of ICDR Regulations, an issuer is not eligible to make an initial public offer if there are any outstanding convertible securities or any other right which would entitle any person with any option to receive equity shares of the issuer. There is no such similar restriction under IFSC Regulations.

The following companies are ineligible, in case of offer for sale by existing shareholders:

Figure 5: Companies ineligible under NDI Rules, in case of offer for sale

Companies Ineligible under IFSC Regulations

Companies incorporated in India/IFSC/foreign jurisdiction are allowed to list on IFSC Exchanges, however, the issuer, any of its promoters, controlling shareholders, directors or existing shareholders offering shares should not be

  • debarred from accessing the capital market; or
  • a wilful defaulter; or
  • a fugitive economic offender

Further, Regulation 9 of IFSC Regulation prescribes certain eligibility criteria for listing such as operating revenue, minimum market capitalization, PBT, etc. (Refer our article IFSC Gateway to Global Access for Indian unlisted companies to understand the conditions in detail). Hence, the entities that are not ineligible as per LEAP Rules, NDI Rules, and IFSCA Regulations and fulfilling the eligibility criteria of IFSC Regulation can list its equity shares in IFSC Exchanges.

Permissible holder

Para 2 of Schedule XI to NDI Rules provides the eligibility criteria for the permissible holders of equity shares listed on permissible stock exchanges. Any Person Resident Outside India (‘PROI’) can be a permissible holder. Thus, an Indian resident cannot hold such shares, however a non-resident Indian can hold such shares (FAQ no. 15 & 16). The said conditions are also applicable to a beneficial owner.[3]

Where a holder is a citizen of a country which shares land border with India, or an entity incorporated in such a country, or an entity whose beneficial owner is from such a country, they can hold equity shares of such a public Indian company only with the approval of the Central Government.

To ensure that the investor is aware of the above conditions of the permissible holders, the Indian company is required to indicate the same in its offer document issued while raising funds in Gift City.

Voting rights on such equity shares will be exercised directly by the permissible holder or through their custodian pursuant to voting instruction only from such permissible holder.

As per RBI Master Directions – Liberalized Remittance Scheme (LRS) investments in IFSCs in securities except those issued by entities or companies in India (outside IFSC) were permitted. RBI Circular dated July 10, 2024 permits availing of financial services or financial products[4] (which inter alia includes securities)within IFSC. However, this cannot be construed to override the eligibility of ‘permissible holder’ prescribed under NDI Rules.

Investment Limit for permissible holder

A permissible holder can invest upto the limits prescribed for foreign portfolio investors i.e. less than 10% of the total paid-up equity capital on a fully diluted basis. That means one single investor can hold less than 10% of the equity share capital on a fully diluted basis of the public Indian Company.

Manner of Purchase/Sale

A permissible holder is allowed to pay the purchase/subscription consideration either to a bank account in India or deposited in a foreign currency account of the Indian company held in accordance with the FEM (Foreign currency accounts by a person resident in India) Regulations, 2015, as amended from time to time.

In case of a sale, the consideration may be remitted out of India or can be credited to the bank account of the permissible holder maintained in accordance with FEM (Deposit) Regulations, 2016 i.e. NRO/ NRE/ FNCR/ SNRR account.

Cap on Foreign Funds

Schedule I to NDI Rules provides the sectoral caps, i.e. the maximum foreign investment permissible in a particular sector. The said conditions are to be complied in case of listing on permitted stock exchanges as well since, listing on IFSC will result in raising funds from PROI. Accordingly, amounts offered to PROI in permissible jurisdiction along with equity shares held in India by PROI should be compliant of the sectoral cap. The aggregate amount held by PROI should not exceed the limits prescribed.

Further, wherever Government approval is required under Schedule I, the same shall be obtained while raising funds from permitted foreign exchange. Eg. in case of print media, foreign investment upto 26% is permitted under government route, therefore a company engaged in print media business can raise only upto 26% from permitted stock exchanges after obtaining requisite approval. 

Also, the company has the option of receiving the funds either in the bank account maintained in India or in the foreign currency account maintained outside India. Indian companies are allowed to keep funds in the foreign currency account maintained with the Bank outside India, until its utilization or repatriation to India. 

Pricing of Equity Shares

Para 6 of Schedule XI to NDI Rules provides for pricing of equity shares to be listed on the permitted stock exchange. LEAP Rules does not prescribe any pricing conditions.

Figure 6: Pricing of equity shares

Other actionable

  • The unlisted public company is required to file the prospectus in form LEAP-1 with ROC within a period of seven days after the same has been finalised and filed in the permitted exchange.
  • Post listing, the company will be required to prepare the financial statements as per Ind AS in addition to any other accounting standard, if applicable.
  • The Indian company will be required to report to RBI through AD Banks in form LEC (FII) about the purchase/subscription of equity shares listed on IFSC Exchanges.[5]

Direct listing overseas v/s depository receipts

Issuance of depository receipts is governed by Depository Receipt Scheme, 2014 read with FEMA NDI Rules and SEBI’s framework for issue of depository receipts. The regime is different from the issue of ADR/ GDR and listing on overseas exchanges.

  • While the Scheme provided for any Indian company being eligible to issue depository receipts, SEBI restricted the eligibility to issue only by ‘a company incorporated in India and listed on a recognised stock exchange in India’. Therefore, unlisted entities are not eligible to issue depository receipts.
  • Mode of listing of DRs are similar to present regime i.e. fresh issuance or OFS of permissible securities.
  • There are 8 permissible jurisdictions for ADR/GDR issuance[6] as compared to just IFSC in case of direct listing.
  • The concept of permissible holder for depository receipts is similar to permissible holder in the context of direct listing (discussed above) such that residents are not eligible to hold the same even as a beneficial owner. In case of depository receipts, even NRIs are ineligible to invest. However, as clarified by SEBI vide circular dated December 18, 2020 issue of DRs to NRIs is permitted pursuant to share based employee benefit schemes which are implemented by a company in terms of SEBI (Share Based Employee Benefits) Regulations 2014[7] and pursuant to a bonus issue or a rights issue;
  • The norms relating to pricing and voting rights are also on similar lines in both cases.

Status after listing

In case of direct listing, Indian companies would be listing its ‘equity shares’ and/or ‘convertible securities’. The Companies Act, 2013 defines the term ‘listed company’ as a company which has any of its securities listed on any recognised stock exchange. However, clause (c) of Rule 2A of the Companies (Specifications of Definitions Details) Rules, 2014 (‘SDD Rules’) provides that public companies which have not listed their equity shares on a recognized stock exchange but whose equity shares are listed on a stock exchange in a jurisdiction as specified in sub-section (3) of section 23 of the Act shall not be considered as a listed company.

Therefore, the status of an unlisted public company will not change upon direct listing and consequently, the additional compliances as applicable to a listed company under CA, 2013 will not apply to such company in view of express carve-out in terms of the SDD rules.

However, every Indian company getting its securities listed on stock exchanges in IFSC will be required to comply with Chapter XII[8] of the IFSC Regulations dealing with listing obligations and disclosure requirements, as applicable.

Minimum Public Shareholding Requirement

Securities Contracts (Regulation) Rules, 1957 (‘SCR Rules’) mandates listed companies in India to have a minimum public shareholding (MPS) of atleast 25% of each kind of equity shares.

On the requirement for minimum offer and allotment to public, Ministry of Finance vide notification dated 28th August, 2024, amended Rule 19 of SCR Rules prescribing a minimum of 10% irrespective of the post issue paid up capital (as opposed to 25% applicable to listed entities in India) for companies intending to list their securities on recognized stock exchanges in IFSC. Further, the continuous listing requirement in Rule 19A has also been amended prescribing MPS requirement of atleast 10%. In case it falls below 10% at any time, the company will be required to bring the public shareholding to 10%  within a maximum period of 12 months from the date of such fall[9].

In this regard, the working group committee suggested that the public holding fulfilling the definition of public shareholding as per SCR Rules[10] should be considered towards MPS and such requirements should be complied in both jurisdictions separately to ensure free float in both jurisdictions. Basis the recommendations, the working group committee recommended making appropriate changes in the SCR Rule. In view of the aforesaid amendment, it seems that MPS norms are required to be separately maintained.

Tax incentives available to permissible holders

Non-residents i.e. permissible holders are exempt from the applicability of capital gains tax in case of transfer of foreign currency denominated equity shares of a company where the consideration is payable in foreign currency pursuant to Section 47(viiab) of Income Tax Act, 1961 read with Notification dated 5th March, 2020. Also, Securities Transaction Tax, Commodities Transaction Tax, and stamp duty in respect of transactions carried out on IFSC exchanges is exempt.

Conclusion

The initiative is quite encouraging and will benefit India Inc. in fundraising, however, the ineligibility on account of pending inspection/investigation needs to be revisited. The requirements post listing, as per IFSC Regulations are also numerous, several of them being on similar lines as provided under Listing Regulations.


[1] As per the press release by PIB.

[2] Prohibited sectors include- Lottery business, Gambling and betting, Chit funds, Nidhi company, Trading in TDR, (a) Real estate business or construction of farm houses, Manufacturing of cigars, cheroots, cigarillos and cigarettes, of tobacco or of tobacco substitutes, Atomic energy, Railway operations, Foreign technology collaborations in any form for lottery business and gambling and betting activities.

[3] Beneficial owner as defined as per proviso to sub-rule (1) of rule 9 of the Prevention of Money-laundering (Maintenance of Records) Rules, 2005

[4] “financial product” means—(i) securities; (ii) contracts of insurance; (iii) deposits; (iv) credit arrangements; (v) foreign currency contracts other than contracts to exchange one currency for another that are to be settled immediately; and (vi) any other product or instrument that may be notified by the Central Government from time to time.

[5] Inserted vide FEM (Mode of Payment and Reporting of NonDebt Instruments) (Amendment) Regulations, 2024

[6] 1. United States of America – NASDAQ, NYSE 2. Japan – Tokyo Stock Exchange 3. South Korea – Korea Exchange Inc. 4. United Kingdom excluding British Overseas Territories- London Stock Exchange 5. France – Euronext Paris 6. Germany – Frankfurt Stock Exchange 7. Canada – Toronto Stock Exchange 8. International Financial Services Centre in India – India International Exchange, NSE International Exchange.

[7] The onus of identification of NRIs holders, who are issued DRs in terms of employee benefit scheme, would lie with the listed company. The listed company is required to provide the information of such NRI DR holders to the designated depository for the purpose of monitoring of limits.

[8] Part A: General Obligations; Part B: Companies with Specified Securities Listed on Recognised Stock Exchanges as a Primary Listing and Part C: Secondary Listing of Specified Securities.

[9] Manner of achieving MPS has been prescribed vide SEBI Circular dated February 3, 2023.

[10]Rule 2(e) of SCR Rules defines public  shareholding  as equity shares of the company held by public including  shares underlying the depository receipts if the holder of such depository receipts has the right to issue voting instruction and such depository receipts are listed on an international exchange in accordance with the Depository Receipts Scheme, 2014.

Provided  that  the equity shares of the company held by the trust set up for implementing employee benefit  schemes under the regulations framed by the Securities and Exchange Board of India shall be excluded from public shareholding.

Provided  that  the equity shares of the company held by the trust set up for implementing employee benefit  schemes under the regulations framed by the Securities and Exchange Board of India shall be excluded from public shareholding.


FPIs – Synoptic Overview

Prapti Kanakia and Heta Mehta | corplaw@vinodkothari.com

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Our Resources on the topic:-

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