1. INTRODUCTION
1.1 On August 16, 2024, the Government of India through the Ministry of Finance notified the Foreign Exchange Management (Non-debt Instruments) (Fourth Amendment) Rules, 2024 (“Amendment”) which proposed certain key amendments to the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“Principal NDI Rules”).
2. KEY AMENDMENTS
2.1 Swap of equity instruments
(i) The erstwhile Principal NDI Rules stated that an Indian company may issue equity instruments to a person resident outside India (“NR”) against a swap of equity instruments. The term “equity instruments” under the Principal NDI Rules is defined to mean equity shares, convertible debentures, preference shares and share warrants issued by an Indian company. The literal interpretation of erstwhile Principal NDI Rules thus led to an understanding that an NR was eligible to acquire equity instruments of an Indian company by way of a swap of equity instruments of another Indian company only. This meant that swapping Indian securities with foreign securities required prior approval from the Reserve Bank of India (“RBI”).
(ii) The Amendment now permits ‘swap of equity capital of a foreign company' in compliance with the rules prescribed by the central government, including Foreign Exchange Management (Overseas Investment) Rules 2022 (“OI Rules”), and the regulations specified by the RBI from time to time.
(iii) Under the OI Rules, an overseas direct investment by an Indian entity in the equity capital of a foreign entity has been permitted by way of a swap of securities, provided that both legs of the swap transaction complies with applicable foreign exchange regulations. Further, the term “equity capital” under the OI Rules means ‘equity shares, perpetual capital or instruments that are irredeemable or contribution to non-debt capital which is fully and compulsorily convertible of a foreign entity'. A foreign entity is not just limited to a foreign company but includes any entity registered/incorporated outside India and having limited liability. As a result, a NR holding equity capital of a foreign entity (including LLCs, LLPs, investment funds that qualify) may now swap the same for equity instruments of an Indian company, subject to compliance with provisions of the OI Rules. To meet such requirements, swaps would need to also comply with conditionalities on the number of step-down subsidiaries, requirements of bonafide business activity by the foreign entity, restrictions applicable to remittances/capital acquisition by resident Indian individuals, etc. as set out under the OI Rules.
(iv) With the new provisions allowing a swap of equity capital of a foreign entity without restrictions on the structure (except where government approval is required), parties intending to undertake an ODI-FDI swap, can now explore various options. For example:
- Indian resident shareholders of an Indian company (“R”) can invest in a foreign entity's equity capital, with such foreign entity acquiring equity instruments of the Indian company from such R in return.
- R can exchange equity instruments held by them in an Indian company with equity capital held by NRs in a foreign entity.
- NRs holding equity capital in a foreign entity can acquire shares of an Indian subsidiary of such foreign entity, with the Indian subsidiary acquiring shares of such NR in the said foreign entity in return.
- An investment fund, qualified as a foreign entity can also trade in its units in the same manner as provided above leading to more structuring options for funds restructuring their Indian investments and portfolio holdings.
(v) Such flexibility of structuring options will also provide benefits for both Indian companies as well as foreign entities that now want to relocate/flip from a foreign jurisdiction to India or vice versa. The Indian market is flooded with interests from several companies, which externalised their operations and created holding structures abroad, wanting to come back to India for better valuations, regulatory advantages and/or a favourable IPO market. On the other hand, there continues to be companies wishing to set up a foreign holding company structure. Both will benefit from this move. However, each structure will require careful analysis with authorized dealer banks, and further clarity from the RBI on reporting requirements under the Principal NDI Rules and OI Rules.
2.2 Investment limits for foreign portfolio investors
(i) Under the erstwhile Principal NDI Rules, aggregate foreign portfolio investment in an Indian entity under the foreign direct investment route up to the lower of: (A) 49% (Forty Nine Percent) of the paid-up capital of the Indian entity on a fully diluted basis; or (B) the sectoral or statutory investment cap, did not require governmental approval or compliance with sectoral conditions as long as such foreign portfolio investment did not result in transfer of ownership or control to a person resident outside India.
(ii) The Amendment has now removed the 49% (Forty Nine Percent) requirement. Now, aggregate foreign portfolio investment in an Indian entity can extend up to the sectoral or statutory cap, without the requirement to either obtain governmental approval or comply with sectoral conditions as long as such investment does not result in transfer of ownership and/or control to a person resident outside India.
(iii) For example, the aggregate investment by a foreign portfolio investor in an Indian entity engaged in: (A) publishing of newspaper and periodicals dealing with news and current affairs may extend up to 26% (Twenty Six Percent); (B) up-linking of news and current affairs TV channels may extend up to 49% (Forty Nine Percent); (C) multi-brand retail trading may extend to 51% (Fifty One Percent) (being the sectoral cap); or (D) brownfield pharmaceuticals may extend up to 100% (One Hundred Percent), in each case without the requirement to obtain government approval or comply with the applicable sectoral conditions.
2.3 Foreign investment in white label ATM operations
The Amendment aligns the Principal NDI Rules to the Consolidated FDI Policy of 2020, which permit foreign investment in white label ATM operations (essentially ATMs of non-bank entities) up to 100% (One Hundred Percent) under the automatic route subject to compliance with the following conditions:
(i) any non-bank entity intending to set up white label ATMs should have a minimum net worth of INR 100 crores as per the latest financial year's audited balance sheet, to be maintained at all times;
(ii) In case the Indian entity is also engaged in any ‘Other Financial Services' as referred to in Schedule I of the Principal NDI Rules, then such foreign investment in the Indian entity setting up the white label ATMs shall also comply with the minimum capitalisation norms, if any, for foreign investments in such ‘Other Financial Services'; and
(iii) Foreign direct investment in white label ATM operations will be subject to specific criteria and guidelines issued by the RBI under the Payments and Settlements Systems Act, 2007.
2.4 Other changes to harmonize or to clarify:
(i) Definition of ‘control' – has now been linked with the definition of ‘control' under the Companies Act, 2013 and specifically in relation to Limited Liability Partnerships (“LLP”), retains the original construct of having the right to appoint a majority of the designated partners, where such designated partners, with specific exclusion to others, have control over all the policies of an LLP. This definition which was earlier set out in Rule 23 of the Principal NDI Rules pertaining to downstream investments has now been harmonized and moved to section setting out the main definitions and consequent changes across the Principal NDI Rules have been carried out.
(ii) Definition of ‘startup' – has now been updated to refer to the notification dated February 19, 2019, issued by the Department for Promotion of Industry and Internal Trade, Ministry of Commerce and Industry. Similar amendments have been previously carried out to the Insolvency and Bankruptcy Code, 2016 and the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012.
(iii) Requirement to obtain government approval – The Principal NDI Rules has been amended to state that prior government approval shall be obtained for any transfer of shares in all cases wherever government approval is applicable, with the intent to cover all cases apart from investment in a regulated sector where a government approval is prescribed, for example, investment from a country sharing a land border with India irrespective of the sector in which the investment is proposed.
(iv) Calculation of indirect foreign investment – The provisions in relation to downstream investment have been amended to clarify that any investment made by an Indian entity which is owned and controlled by an overseas citizen of India including a company, a trust and a partnership firm incorporated outside India and owned and controlled by a non-resident Indian or an overseas citizen of India, on a non-repatriation basis, shall also not be considered for calculation of indirect foreign investment (given that such investments are deemed on par with resident investments). The erstwhile Principal NDI Rules provided this exemption only in relation to Indian entities owned and controlled by a non-resident Indian.
3. QUICK VIEW
3.1 The Amendment marks a significant shift in India's foreign investment landscape and has enhanced the opportunities available to both Indian and international players looking to optimize their investment and operations in India or abroad based on their requirements. The eased FDI-ODI swaps, relaxed FPI norms and clarity on white label ATM operations each indicate a move in the right direction. For example, by allowing swap transactions involving foreign capital, a new avenue has been opened up for foreign companies with Indian subsidiaries to domicile and relocate to India, which is an interesting counter-trend being seen with new age businesses intending to benefit from the growth story and exit opportunities of new India. As always, detailed analysis and careful planning are essential to fully leverage these changes while staying compliant with the evolving regulatory framework and clarifications on procedural compliance (including those on swap) would be welcome.
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