The Reserve Bank of India (RBI) has issued guidelines for the reclassification of Foreign Portfolio Investment (FPI) to Foreign Direct Investment (FDI) under the Foreign Exchange Management (Non-debt Instruments) Rules, 2019, effective October 17, 2019. This framework applies to FPI investments that exceed the 10% threshold of a company’s paid-up equity capital on a fully diluted basis. When this limit is breached, the FPI has the option to either divest the excess holdings or reclassify them as FDI. Authorized Dealer (AD) Category-I banks are required to assist with the reporting and processing of these transactions under the provided framework.
Key Steps and Requirements
- Sector Restrictions: Reclassification from FPI to FDI is not permitted in sectors where FDI is prohibited.
- Approvals Needed: Before reclassifying, the FPI must obtain necessary government approvals. This includes any special permissions required for investments from countries bordering India. The FPI must also comply with existing FDI guidelines, including entry routes, sectoral caps, investment limits, pricing guidelines, and other conditions under Schedule I of the Rules. Additionally, the Indian investee company must provide concurrence, confirming that the reclassification aligns with sectoral caps and government approvals.
- Freezing of Transactions: Once the FPI articulates its intent to reclassify its investment and secures the necessary approvals, it must submit these documents to its Custodian. The Custodian will then freeze the FPI’s purchase transactions in the company’s equity instruments until the reclassification process is complete. If the FPI fails to obtain approvals within the prescribed time (five trading days from the breach), the excess investment must be compulsorily divested.
- Reporting Requirements: For reclassification, the entire FPI investment must be reported within specific timelines. If the excess results from new equity issuance, the Indian company reports it using form FC-GPR. If the breach arises from secondary market acquisitions, the FPI reports it using form FC-TRS. The concerned AD bank must record this reclassification as divestment in the LEC (FII) reporting.
- Transfer of Equity Instruments: After completing the reporting, the FPI requests its Custodian to transfer the equity instruments from its FPI demat account to an FDI account. Once all reporting is confirmed, the Custodian unfreezes the equity instruments and processes the transfer. The date of the breach is considered the date of reclassification, after which the investment will be treated as FDI, even if the FPI holding subsequently falls below 10%.
- Continued Compliance: Post-reclassification, the investment is governed by Schedule I of the Rules, and the FPI and its investor group will be treated as a single entity for FDI purposes.
