India’s RBI Introduces Framework for Converting FPI to FDI in Indian Companies

Posted by Written by Archana Rao Reading Time: 3 minutes

The Reserve Bank of India (RBI) has streamlined the process for Foreign Portfolio Investors (FPIs) to reclassify their holdings as Foreign Direct Investment (FDI) if their stake in an Indian company exceeds 10 percent. Previously, FPIs exceeding this cap were required to either divest the surplus shares or reclassify them as FDI.

India’s Reserve Bank of India (RBI) has introduced a streamlined framework allowing Foreign Portfolio Investors (FPIs) to convert their holdings into Foreign Direct Investment (FDI) if they surpass the 10 percent equity limit in an Indian company. The RBI notification on November 11, 2024, provides a clear pathway for FPIs who unintentionally exceed the threshold, enabling them to maintain investments under FDI guidelines.

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The new RBI framework allows FPIs to hold investments beyond a certain limit in Indian companies by converting any excess as FDI. For instance, an FPI holding a 22 percent stake can classify the surplus 12 percent as FDI, provided it has the necessary approvals from the government and the investee company.

According to several investment experts, this change could benefit Indian companies by making it easier to attract additional foreign investment.

Key highlights of the new framework

FPI ownership limit

  • Current cap: FPIs in India are restricted to holding a maximum of 10 percent of a company’s paid-up equity.
  • Exceeding the cap: If this cap is surpassed, FPIs previously had to either sell off the excess shares or reclassify them as FDI.
  • New requirement: Under the new RBI guidelines, reclassification to FDI must occur within 5 trading days of breaching the limit, with approval from the Indian government and the relevant company. Reclassification remains restricted in sectors where FDI is limited.

List of prohibited sectors for FDI as specified by the central government:

  • *Lottery Business including government/ private lottery, online lotteries etc.
  • Chit funds
  • Trading in transferable development rights (TDR)
  • Manufacturing cigars, cheroots, cigarillos, and cigarettes (tobacco or tobacco substitutes)
  • Gambling and betting, including casinos*
  • Nidhi company
  • **Real estate business or construction of farmhouses
  • Sectors not open to private sector investments – atomic energy, railway operations (other than permitted activities mentioned under the consolidated FDI Policy)

*Foreign technology collaboration in any form, including licensing for franchise, trademark, brand name, and management contract is also prohibited for lottery business and gambling and betting activities.

**Real estate business shall not include the development of town shops, construction of residential/commercial premises, roads or bridges, and Real Estate Investment Trusts (REITs) registered and regulated under the SEBI (REITs) Regulations, 2014.

Compliance and reclassification requirements

Steps for reclassification:

1. Compliance reporting: FPIs must adhere to the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019.

After completing the required reporting, FPIs must instruct their custodians to transfer shares from the FPI demat account to a designated FDI demat account.

2. Intent and custodian notification: If an FPI intends to reclassify its holdings, the custodian must report this to SEBI and halt further equity purchases by the FPI until reclassification is finalized.

Immediate enforcement and scope

This framework is effective immediately, empowering the Securities and Exchange Board of India (SEBI) to protect investor interests, maintain compliance, and uphold the integrity of the securities market. Issued to:

  1. Foreign Portfolio Investors (FPIs)
  2. Designated Depository Participants (DDPs) and Custodians
  3. Depositories
  4. Stock Exchanges and Clearing Corporations

SEBI’s parallel guidelines

The RBI’s framework aligns with recent SEBI updates, effective May 30, 2024, which also outline procedures for reclassifying FPI holdings that exceed the 10 percent threshold.

SEBI requirements for reclassification:

  • Notification by custodian: When an FPI crosses the 10 percent threshold, the custodian must notify SEBI and suspend additional equity transactions in the company until reclassification is complete.
  • Transfer of holdings: The custodian will assist in moving the securities to an FDI-designated account after all necessary compliance and reporting requirements are met.

Difference between FDI and FPI

FDI refers to a long-term investment where a foreign investor acquires an ownership stake in an Indian company, project, or central government initiative. This category of investment requires direct government approvals and bypasses stock market transactions.

FPI, in contrast, involves short-term investments in a country’s financial assets, such as stocks and bonds. FPI flows through stock markets or initial public offerings (IPOs) and can be traded at any time for profit.

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