Foreign Portfolio Investment

RBI to Reclassify FPI Investment as FDI Above 10% Holding

The Reserve Bank of India (RBI) has recently released a new set of guidelines which has been aim at to the clarity of reclassifying Foreign Portfolio Investment (FPI) as Foreign Direct Investment (FDI) in situations where the stakes of FPI exceeds 10% in an Indian company. This update has responded to the need for clear procedures, explicitly considering the upsurge in foreign interest in Indian companies and imbibing regulatory framework surrounding FPI and FDI.

By providing a proper framework, the RBI looks forward to aligning FPI and FDI classification to ensure better compliance, safeguard India’s economic interests, and support more effective management of foreign investments in the country.

Understanding FPI and FDI in India

Foreign Portfolio Investment (FPI) and Foreign Direct Investment (FDI) are two sets of foreign investments with unique implications and characteristics.

FPI: Typically involves purchasing securities, like shares in a company, without a substantial controlling interest. Generally, this type of investment is liquid, short-term and more accessible to withdraw, which appeals to investors seeking flexibility.

FDI: Contrastingly, FDI is more of a significant commitment comprising more direct and long-term investment where a foreign entity gains a valuable stake and potentially influences company decisions.  FDI is generally tied to capital assets, operational influence, and strategic control, which are essential for a country’s economic stability and growth.

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These two play an essential role in supporting the development of the economy but are subject to different regulatory standards. FPI investments are regulated to make sure they remain as portfolio holdings without any major influence on the operations of the company. Whereas in contrast, FDI investments need compliance with specifications to sector caps, entry routes, and guidelines to monitor the extent of foreign control. India’s regulatory bodies establish distinct rules for each sector to balance attracting foreign capital and maintaining economic individuality.

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Existing Limit of FPI Holdings

RBI currently restrict FPIs from holding more than 10% of a company’s total paid-up equity capital as a part of a portfolio investment. If FPI’s stakes cross the threshold of 10%, it will trigger a mandatory reclassification from FPI to FDI. This rule has been set to prevent FPIs from gaining any significant control or any influence over Indian firms while still allowing substantial participation from foreigners in the stock market. Reclassifying FDI to FPI investment changes the nature of holding and requires the investor to meet additional regulatory obligations under FDI norms, which include sectoral caps, restrictions and technical guidelines.

This rule ensures that FPI investment remains financial and does not cross the executive influence or control, a hallmark of FDI. The recent guidelines rationalise how such reclassification will be handled, addressing the uncertainty around how and when foreign portfolio managers must report and reclassify their holdings after crossing this threshold.

New RBI Guidelines to Reclassify FPI Investment

This new rule to reclassify FPI investment as FDI above 10% holding introduces a systematic approach for crossing the threshold. Below, we have discussed the outline of the steps and requirements under the new framework:

1.      Completion of Regulatory Reporting

FPI should complete all the required regulatory reporting for reclassification. This includes submitting all required documents, approvals, and compliance confirmations related to the change in the investment status.

2.      Request to Custodian for Transfer

Once the reporting is complete, the FPI should approach its custodian– typically a finance institution or bank that acts as a custodian for FPI holdings. FPI can formally request the custodian to transfer the equity instruments like shares and securities of the Indian company from their FPI demat account, which is used for holding the portfolio investments, to the FDI demat account, which is used for holding foreign direct investments.

3.      Custodian Verifies Reporting and Unfreezes Equity Instruments

Now, the custodian will verify that the required documentation and regulatory reporting have been adequately completed. Once it has been satisfied that the reclassification reporting is complete, they will unfreeze the equity instruments held in the FPI’s demat account and initiate the transfer process.

4.      Determination of Reclassification Date

The date on which the FPI holding crosses the 10% threshold and triggers the reclassification will be considered the date of reclassification.

5.      Reclassification as FDI

Once the transfer is complete, the entire investment of the FPI in the Indian company will be considered FDI, regardless of whether the holding drops below 10% at any point in the future.

The FPI holding will remain classified as FDI permanently, it will not revert to FPI status.

6.      Single Entity Classification

For the goal of reclassification, the FPI and any other entities in its investor group will be regarded as one individual or a single person. All the associated parties in the investment group will be collectively considered when assessing whether the 10% threshold has been breached, and the reclassification will apply to the whole group’s holdings.

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Impact of the New Guidelines on FPIs and Indian Companies

For FPIs: The new guidelines added clarity and responsibility while aiming to increase their ownership stake. Now, they must follow a concentrate procedure, which minimises regulatory uncertainty and aids smoother transitions of investors with a long-term interest in Indian firms. This rule helps FPIs adjust their portfolio strategies, knowing the steps involved when moving from FPI to FDI status.

For Indian Companies: With transparency in shareholder composition, companies can better plan and manage their shareholder structure. Reducing the ambiguity for businesses, ensuring they can anticipate and adapt to potential FDI transitions within their investor base.

Challenges and Considerations for FPIs

RBI’s new framework for reclassifying FPI investment as FDI also introduces several challenges for foreign investors:

1. Increased Regulatory Burden: Now, FPIs will face additional compliance requirements, specifically for investments exceeding the 10% threshold, including having government approval, which can be time-consuming and complex.
2. Coordination with Custodians: The reclassification process requires FPIs to get aligned and work closely with custodians to ensure the smooth transfer of equity instruments, which could also cause delays or errors if not managed carefully.
3. Investment Strategy Adjustments: The shift from FPI to FDI enforces strict regulations, which include sectoral caps and pricing norms, which may limit flexibility for FPIs, especially those focused on short-term returns.
4. National Security Inspection: Foreign Portfolio Investors from neighbouring countries face an upsurge in scrutiny, complicating the approval process and potentially impacting investment decisions.
5. Documentation and Timing: Postponements in obtaining the approvals or submitting documentation could interrupt the transfer process, particularly in unpredictable market conditions.

Conclusion

The Reserve Bank of India’s new guidelines provide a clear picture of the reclassify FPI investments to FDI as soon as it triggered the threshold of 10% holding. While the particular framework enhances transparency, it introduces operational challenges for FPIs, including compliance, getting aligned with custodians, and adjustments to investment strategies. For FPIs, those who are near the 10% threshold, this reclassification requires careful management of both regulatory and strategic considerations. Eventually, this rule contributes to a more predictable investment environment, balancing foreign capital inflows with India’s economic security. For consulting support for FDI under automatic route and foreign portfolio investor registration, visit https://enterslice.com/.

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