Reclassification of FPI to FDI – Operational Framework

The Reserve Bank of India (RBI) issued a circular A.P. (DIR Series) Circular No. 19, outlining the operational framework for the reclassification of Foreign Portfolio Investments (FPIs) to Foreign Direct Investments (FDIs). This circular primarily addresses investments exceeding the prescribed limit set for FPIs and provides a structured approach for converting such investments into FDI. 

The FPIs are primarily seen as short-term investors in India’s equity markets, who typically buy and sell stocks to generate quick returns, thus adding volatility to the market. In contrast, FDIs signify a long-term commitment to the country, which involves active participation in the company's management and operations and are generally viewed as more stable and desirable because they often lead to technology transfer, job creation, and infrastructure development. 

By allowing a smooth transition from FPI to FDI, the RBI aims to encourage stable, long-term capital flows into India’s economy, ensure that large foreign investors with substantial stakes in Indian companies can make their investments compliant with the FDI rules and reduce the volatility caused by excessive short-term foreign investments in the stock market.

 Adherence to Regulatory Limits

The Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 prescribe that FPIs should not hold more than 10% of a company’s total paid-up equity capital on a fully diluted basis. This limit ensures that FPIs do not acquire significant control over Indian companies, as they are typically viewed as passive investors.

 Trigger for Reclassification from FPI to FDI

The operational framework starts when an FPI, along with its investor group, exceeds the 10% limit in an Indian company, either through new equity issuance or purchases in the secondary market.

 Timeframe for Reclassification

Once the limit is breached, the FPI has five trading days from the settlement date of the trade causing the breach to either divest the excess holding by selling equity instruments to a person resident in India who is eligible to hold such instruments or reclassify it as FDI.

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

1.       Prior Approval of the Government, if applicable – The FPI shall obtain necessary approvals from the Government, if applicable, including approvals required in case of investment from land bordering countries and ensure that the acquisition beyond the prescribed limit is made by the provisions applicable for FDI, which means that investment should be in adherence to entry route, sectoral caps, investment limits, pricing guidelines, and other attendant conditions for FDI. 

2.       Concurrence of the Indian investee company - The FPI shall obtain the Concurrence of the Indian investee company for reclassification of the investment to FDI to enable such company to ensure compliance with FDI-linked conditionalities. 

3.       Notification of intent - The FPI must formally notify its custodian of its intent to reclassify its investment from FPI to FDI. This is followed by submitting the necessary approvals and concurrences to the custodian. Pursuant to this notification, the Custodian shall freeze the purchase transactions by such FPI in equity instruments of such Indian company, till completion of the reclassification. However, 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. 

4.       Reportings for reclassification – the concerned parties shall undertake the following applicable reporting requirements:

a.       Form FCGPR - By the Indian company, where the investment beyond the prescribed limit is resulting from fresh issuance of equity instruments by an Indian company to such FPI;

b.       Form FCTRS - By the FPI, where the investment beyond the prescribed limit is due to the acquisition of equity instruments by such FPI in the secondary market

c.       Form LEC (FII) – By the AD Bank, which shall report the amount of reclassified foreign portfolio investment as divestment. 

5.       Request for transfer of instruments - 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. Once the custodian verifies that all reporting requirements for reclassification are fully met, they will unfreeze the equity instruments and proceed with the transfer. 

The date of investment causing a breach in such cases shall be considered as the date of reclassification. Thereafter, 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 ten percent subsequently. The Foreign Portfolio investor along with its investor group shall be treated as a single person for the purpose of reclassification of foreign portfolio investment.

The RBI’s framework for reclassifying FPIs to FDIs allows FPI who breach the 10% investment threshold to align their holdings with FDI regulations, provided they meet certain conditions. This move is designed to encourage stable, long-term capital flows into India, while also providing investors with the flexibility to maintain or increase their stakes in Indian companies under the FDI regime. It reflects India’s ongoing efforts to integrate global investment into its economy, fostering growth while managing risks and ensuring regulatory compliance.

Authors: I Abhishek Bansal , Partner (abhishek.bansal@acumenjuris.com) I Laxmi Sinha , Principal Associate (laxmi.sinha@acumenjuris.com) I ACUMEN JURIS

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Disclaimer- This Article is for information purposes only, and the views stated herein are personal to the author, and shall not be rendered as any legal advice or opinion to any person, and accordingly, no legal opinion shall be rendered by implication.