On January 20, 2025, the Reserve Bank of India ("RBI") introduced significant updates to its master directions on foreign investment in India ("Master Directions"). This move aims to provide clarity on various regulatory aspects, particularly concerning downstream investments by Foreign-Owned or Controlled Companies ("FOCCs"), compliance obligations, and overall alignment with market practices. Additionally, the updated guidelines incorporate amendments to the Foreign Exchange Management (Non-Debt Instrument) Rules, 2019 ("NDI Rules"), facilitating cross-border mergers and acquisitions through secondary share swaps. This article breaks down the key changes and their implications for businesses and investors.
Clarifications on Downstream Investments by FOCCs
One of the most crucial aspects of the updated Master Directions is the clarification regarding downstream investments made by FOCCs. Previously, ambiguities surrounded investment structures such as share swaps and deferred consideration arrangements. The RBI has now brought FOCC downstream investments at par with foreign direct investment ("FDI"), making the rules more transparent and investor-friendly. Some takeaways include:
- Equity Swaps and Deferred Consideration: FOCCs can now structure their downstream investments using equity swaps and deferred consideration mechanisms, which were previously restricted, despite being permitted under direct FDI rules;
- Deferred Consideration Flexibility: FOCCs can now execute tranche-based payments and post-closing price adjustments without requiring prior RBI approval, in line with the FDI rules under Rule 9(6) of the NDI Rules; and
- Compliance with Rule 23: FOCCs must ensure that all downstream investments comply with Rule 23 of the NDI Rules, which prohibits using domestically borrowed funds for such investments.
Mandatory Reporting for Reclassified Investments
The RBI has also introduced a new requirement for entities that transition from resident to FOCC status. Such entities must now report this change to the RBI via Form-DI within 30 (thirty) days. While some Authorized Dealer (AD) banks were already following this practice informally, the update now formalizes this requirement, ensuring transparency and compliance.
Guidelines on Rights Issues for Non-Resident Investors
The Master Directions also provide clarity on the treatment of rights issues involving non-resident shareholders, particularly regarding pricing rules. The key updates include:
- Proportionate Subscription: When non-residents subscribe to their entitled shares under Section 62(1)(a)(i) of the Companies Act, 2013, pricing guidelines do not apply;
- Unsubscribed Portions: If the board of directors allocates unsubscribed shares to a non-resident under Section 62(1)(a)(iii), pricing guidelines must be followed; and
- Renounced Shares: If a resident renounces their rights to a non-resident under Section 62(1)(a)(ii), the shares must be issued at or above fair market value.
Foreign Investment for Net-Owned Funds ("NOF") Compliance
A major shift in the regulatory framework now permits financial sector entities to receive foreign investment to meet NOF requirements without prior government approval. Previously, companies seeking registration as a non-banking financial company or other regulated entities had to obtain prior clearance from the Department of Economic Affairs, which was a lengthy and bureaucratic process. Now, such companies can directly receive foreign investment to meet the NOF requirement, simplifying the process significantly.
Prohibited and Restricted Sectors for Foreign Investment
The RBI has reaffirmed restrictions on foreign investments in certain sectors, including:
- Prohibited Sectors: Lottery, gambling, chit funds, Nidhi companies, real estate trading, tobacco manufacturing, atomic energy, and railway operations;
- Restricted Investments: Investments from countries that share a land border with India now require prior government approval;
- Pakistani Investors: Citizens or entities from Pakistan can only invest in non-sensitive sectors and must secure prior clearance from the Government of India; and
- Ownership Changes: If a change in beneficial ownership results in control shifting to a restricted investor, prior government approval is mandatory.
Treatment of Inherited Equity Instruments by Non-Residents
Another significant clarification relates to equity instruments inherited by non-residents from deceased residents. The RBI has now confirmed that such shares must be held on a non-repatriation basis and that no separate reporting is required for such transmissions.
Alignment with NDI Rules and Other Notifications
To maintain regulatory consistency, the updated Master Directions align key definitions such as "control", "convertible note", and "sweat equity" with the NDI Rules and other government notifications. By doing so, the RBI ensures that all stakeholders—including foreign investors, domestic businesses, and regulators operate under a unified and transparent framework.
Conclusion
The RBI's latest updates to its Master Directions on Foreign Investment introduce important clarifications and structural improvements to India's foreign investment framework. By streamlining rules on downstream investments, rights issues, NOF requirements, and restricted sectors, these updates are expected to improve ease of doing business and investor confidence. For foreign investors and businesses, these updates provide a clearer regulatory roadmap, reducing uncertainty and simplifying compliance. As India continues to refine its foreign investment policies, these changes mark another step towards a more transparent and investor-friendly regulatory environment.
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