Operational Framework for Reclassifying FPIs as FDIs

 The Reserve Bank of India (RBI) has introduced an operational framework under the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (NDI Rules), effective November 11, 2024. This framework provides guidelines for reclassifying Foreign Portfolio Investments (FPIs) as Foreign Direct Investments (FDIs) when FPIs exceed the prescribed 10% investment threshold in listed or to-be-listed companies.

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Key Highlights

Current Framework

• Divestment Requirement: FPIs exceeding the 10% threshold must divest holdings within five trading days.
• Failure to Divest: If divestment is not completed, the entire investment is reclassified as FDI, and further FPI investments are restricted.

Reclassification Framework

1. Prohibited Sectors

   • Reclassification is prohibited in sectors where FDI is restricted. In such cases, investors must divest their holdings.

2. Prior Approvals

   • Government Approvals: Necessary approvals are required, especially for investments originating from bordering countries.
   • Investee Company Consent: Approval from the investee company is mandatory to proceed with reclassification.

3. FDI Compliance

   • Investments reclassified as FDIs must adhere to FDI-specific rules, including sectoral caps, pricing guidelines, and investment limits.

4. Intent Declaration

   • Investors must clearly state their intent to reclassify, providing relevant approvals to custodians. Until the process is completed, further equity transactions in the concerned company are frozen.

Procedural Conditions

1. Reporting Requirements

   • Reclassified investments must be reported using:
     • Form FC-GPR: For subscriptions to equity instruments.
     • Form FC-TRS: For equity purchases.

2. Custodian Responsibilities

   • Ensure reporting compliance.
   • Transition equity instruments from the FPI demat account to the FDI demat account.

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Enforcement and Monitoring

• The Securities and Exchange Board of India (SEBI) has revised its Master Circular to align with the reclassification framework.
• Success of the framework relies on adherence by industry stakeholders and proper implementation of compliance measures.

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Conclusion

The reclassification framework streamlines the conversion of FPIs into FDIs, fostering flexibility for investors to exceed the 10% threshold while ensuring strict compliance with FDI regulations. By enhancing clarity, this framework is expected to encourage foreign investments, though its long-term effectiveness will depend on robust implementation and industry alignment.