As per investment restrictions prescribed in Regulation 20(7) of the Securities and Exchange Board of India (Foreign Portfolio Investors) Regulations, 2019 (FPI Regulations), a single Foreign Portfolio Investor (FPI) (including its investor group) is permitted to invest up to 10% of the total paid-up equity capital on a fully diluted basis, in a particular company. In case such FPI (including its investor group) investment’s exceed the aforesaid threshold, the FPI is required to divest its excess holding (over and above the threshold) within five trading days (from the date of settlement of trades leading to the breach). On failure to divest its excess holding, the entire shareholding by the FPI in the company would be construed as foreign direct investment (FDI).
In this regard, Securities and Exchange Board of India (SEBI) and the Reserve Bank of India (RBI) have released two separate circulars dated November 11, 2024 detailing the procedure for reclassification of an FPI’s investment in a particular company as FDI.
SEBI, in its circular (SEBI Circular), requires FPIs to adhere to foreign exchange rules in respect of those investments which are intended to be reclassified as FDI. Upon receipt of receipt for reclassification from the FPI, the custodian is required to report the same to SEBI and suspend all further purchase transactions of the FPI related to the equity instruments of the relevant Indian company until conclusion of the reclassification. The custodian will transfer equity instruments from its FPI demat account to the demat account held for FDI holdings once reporting for reclassification (as per RBI’s guidelines issued in that regard) has been completed.
As per the circular issued by the RBI (Operational Framework), such reclassification from FPI to FDI investment would not be permitted in sectors where FDI is restricted and/or prohibited. Any further acquisition by the FPI beyond the aforesaid threshold can be undertaken once the FPI obtains the following approvals:
- approvals from the government including approvals required in cases of investments from land bordering countries; and
- concurrence of the investee company for reclassification of the investment to FDI. This ensures that the concerned company is in compliance with FDI related conditions, including sectoral prohibitions, sectoral caps, and necessary government approvals, as applicable under the NDI Rules.
In addition to the foregoing approvals, FPI is required to comply with FDI provisions such as adherence to provisions relating to entry route, sectoral caps, investment limits, pricing guidelines and other attendant conditions including reporting the transactions through Form FC-GPR or FC-TRS (as applicable) as enlisted in Schedule I of Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (NDI Rules). If the foregoing approvals are not obtained, the FPI is required to divest its excess holding. Additional reporting is required to be undertaken through LEC (FII) reporting.
Conclusion:
The aforesaid framework for reclassification of FPI’s investments provides much needed clarity on the procedure to be followed for reclassification of shareholding excess of permitted FPI threshold while also clarifying the compliance and approval requirements which are required for such reclassification.