RBI Issues Operational Framework for Reclassification of FPI Investments as FDI

In a significant move to streamline foreign investments and ensure regulatory compliance, the Reserve Bank of India (RBI) has introduced an operational framework for reclassifying investments made by Foreign Portfolio Investors (FPIs) as Foreign Direct Investment (FDI) when prescribed limits are breached. The Securities and Exchange Board of India (SEBI) has also issued a corresponding circular outlining the procedures for this reclassification.

This development aligns with the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (NDI Rules), ensuring compliance in cases where an FPI exceeds the 10% investment cap in Indian listed companies.

Under Schedule II of the NDI Rules, FPIs and their investor groups are restricted to holding less than 10% of the total paid-up equity capital of an Indian listed company on a fully diluted basis. In cases of breach, FPIs have the option to divest excess holdings or reclassify them as FDI.

Key Highlights of the Framework:

• Consent and Approvals:

1. The FPI must secure the consent of the Indian investee company.
2. Prior approvals from the Government of India (GoI) are mandatory for specific sectors or acquisitions and for investments originating from land-bordering countries.
3. No reclassification is permitted in sectors prohibited for FDI.

• Reclassification Process:

1. FPIs must declare their intent to reclassify investments as FDI to their custodian.
2. The custodian will freeze further purchases by the FPI until the reclassification is complete.
3. In the absence of approvals, excess investments must be divested within the prescribed time.

• Reporting Obligations:

Investments must be reported per timelines under the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019 in the following manner:

1. New equity issuances: reported via Form FC-GPR.
2. Secondary market acquisitions: reported via Form FC-TRS.
3. Authorized Dealer Category-I banks: Reclassified FPIs as divestments in LEC (FII) reporting.

• Operational Considerations:

1. The date of breach of the investment limit will serve as the reclassification date.
2. Following reporting completion, FPIs must request their custodians to transfer equity instruments from their foreign portfolio investment demat account to an FDI-specific demat account.

• Post-Reclassification:

1. Investments will fall under Schedule I of the NDI Rules, governing FDI.
2. Once reclassified, the investment will be treated as FDI, even if the holding falls below the 10% threshold later.

The operational framework ensures a streamlined, transparent approach to reclassification, enabling FPIs to navigate regulatory requirements efficiently. It also safeguards the interests of Indian companies by ensuring compliance with foreign investment limits.

This initiative underscores the RBI’s commitment to fostering a robust and compliant investment environment, promoting both foreign portfolios and direct investments into India’s markets.