Bridging Investment Categories: Operational Framework for Reclassification of FPI to FDI

On November 11, 2024, the Reserve Bank of India (RBI) issued a landmark operational framework to streamline the process for reclassifying Foreign Portfolio Investments (FPI) into Foreign Direct Investment (FDI). This announcement, under Circular No. 19 (A.P. DIR Series), has significant implications for global investors and Indian investee companies alike, providing clarity on compliance and procedural aspects.

Key Highlights of the Circular:

1. Prescribed Limit for FPIs: Under the Foreign Exchange Management (Non-debt Instruments) Rules, 2019, FPIs are allowed to hold less than 10% of the total paid-up equity capital of an Indian company on a fully diluted basis. Exceeding this limit triggers the option to either:
2. Reclassification Framework: The framework introduces a robust structure for transitioning investments from FPI to FDI, addressing regulatory nuances, reporting requirements, and sector-specific compliance.

Operational Steps for Reclassification:

1. Sectoral and Regulatory Approvals:

• FDI Prohibited Sectors: Reclassification is strictly prohibited in sectors where FDI is not allowed.
• Government Approvals: Investments exceeding the prescribed limit must align with FDI sectoral caps, entry routes, and obtain necessary approvals, especially in sensitive cases such as investments from land-bordering countries.

2. Indian Company Concurrence:

• The Indian company must provide concurrence to ensure compliance with sectoral caps and government restrictions.

3. Custodian’s Role:

• FPIs intending to reclassify investments must submit requisite approvals and intent documentation to their custodian, who will then freeze the FPI’s equity purchases in the target company.

4. Reporting Requirements:

• Reclassification must be reported under Form FC-GPR (for primary market transactions) or Form FC-TRS (for secondary market acquisitions).
• The Authorised Dealer (AD) bank must reflect these transactions in the LEC (FII) reporting framework.

5. Demat Account Transfers:

• Upon successful reporting, custodians will transfer equity instruments from the FPI demat account to the FDI demat account.
• The date of the investment breach will be treated as the reclassification date.

6. Post-Reclassification Governance:

• Once reclassified, all such investments will be governed under Schedule I of the Non-Debt Instruments Rules, even if holdings subsequently fall below the 10% threshold.

Implications for Stakeholders:

For FPIs:

This framework offers a structured pathway to maintain compliance while enabling continued investment in Indian markets. However, FPIs must act swiftly within five trading days to avoid mandatory divestment.

For Indian Companies:

The concurrence requirement underscores the importance of proactive compliance management and alignment with FDI policies.

For AD Banks and Custodians:

These entities play a pivotal role in ensuring seamless reporting, transaction execution, and regulatory adherence during the reclassification process.

Strategic Perspective:

This operational framework not only reinforces India’s regulatory commitment to transparency and compliance but also offers flexibility to global investors navigating the evolving dynamics of India’s capital markets. The structured transition from FPI to FDI could foster deeper investment relationships, particularly in sectors critical to India’s growth story.

As global markets increasingly converge, this move by the RBI is a testament to India's forward-thinking regulatory stance, aimed at balancing investor interests with national priorities.

By implementing this framework effectively, FPIs, investee companies, and financial intermediaries can ensure seamless compliance while maximizing investment opportunities in India’s thriving economy.

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