Operational framework for reclassification of Foreign Portfolio Investment to Foreign Direct Investment (FDI)

The Reserve Bank of India (“RBI”) vide its circular dated November 11, 2024 has introduced a framework governing the reclassification of Foreign Portfolio Investment (“FPI”) to Foreign Direct Investment (“FDI”). This framework addresses situations where FPI holdings exceed the regulatory threshold of 10% of paid-up equity capital on a fully diluted basis.

Under the Foreign Exchange Management (Non-Debt Instruments) Rules 2019, Foreign Portfolio Investors are allowed to hold up to 10% of a company’s total paid-up equity capital.[1] However, now, any foreign portfolio investor investing above 10% of the total paid-up equity has the option of divesting their holdings or reclassifying such holdings as FDI.

The framework lists down the requirements for the reclassification process:

• Five trading days timeline is to be given from the settlement date for reclassification or divestment
• Reclassification is not permitted in sectors where FDI is prohibited.
• Investors must obtain necessary governmental approvals, particularly relevant for investments from land-bordering countries (refer to press note 3 of 2020[2]).
• Acquisitions exceeding the prescribed limit must comply with FDI provisions, including entry routes, sectorial caps, investment limits, pricing guidelines, and other conditions under Schedule I to the Foreign Exchange Management (Non-debt Instruments) Rules, 2019.[3]
• The Indian investee company (the company receiving the investment) must explicitly agree to the reclassification.
• The operational framework requires Foreign Portfolio Investors to clearly articulate their reclassification intent to their custodian, who then freezes purchase transactions until the reclassification is complete.
• The entire investment must be reported within the timelines according to the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019 , using the FC-GPR form[4] for fresh issuances and the FC-TRS form[5] for secondary market acquisitions, with the Authorized Dealer (AD) bank responsible for reporting the divestment.
• After completing these reports, the Foreign Portfolio Investors requests its Custodian to transfer the equity instruments to the demat account for FDI. The Custodian ensures all reporting is complete, then unfreezes the equity instruments and processes the transfer.
• The date of the investment causing the breach becomes the official reclassification date.
• Once reclassified as FDI, status remains even if the holding falls below 10%.
• 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 reclassification or divestment must be completed within the prescribed time as per Schedule II, and after reclassification, the investment is governed by Schedule I.[6]

[1] Rule 2(t) of the Foreign Exchange Management (Non-debt Instruments) Rules, 2019.

[2] https://dpiit.gov.in/sites/default/files/pn3_2020.pdf

[3]Foreign Exchange Management (Non-debt Instruments) Rules, 2019  (Schedule 1, pg. 71-94)

[4] https://www.rbi.org.in/upload/notification/pdfs/40495.pdf

[5] https://femaonline.com/assets/media/68828Form%20FC-TRS-final%20new.doc

[6]Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (Schedule 1, pg. 71-94) (Schedule 2, pg. 94-96).