The Reserve Bank of India (‘RBI’), by way of Circular dated November 11, 2024, has provided directions on operational framework for reclassification of foreign portfolio investment to foreign direct investment (‘FDI’). Schedule II of the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (‘NDI Rules’) prescribes that the investment made by a foreign portfolio investor (‘FPI’) should be less than 10% of the total paid-up equity capital on a fully diluted basis of a listed Indian company. FPIs, whose investment exceed this threshold may either: (i) divest their holdings; or (ii) reclassify their holdings as FDI, both within five trading days from the date of settlement of the trades causing such breach (‘Prescribed Time’). Pursuant to the same, RBI has issued an operational framework for reclassification of FPI investment into FDI, which may be facilitated by Authorised Dealer (‘AD’) banks.

The key factors of the operational framework are as follows:

i.    reclassification should not be available for any sector where FDI is specifically prohibited;

ii.   the relevant FPI must obtain the following approvals prior to acquiring equity instruments beyond the prescribed limit:

a. all necessary approvals from the Government including Press Note 3 declaration, ensuring acquisition is being made in accordance with the provisions of FDI (in accordance with the prescribed conditions under the NDI Rules); and

b. concurrence of the Indian investee company concerned for reclassification to FDI to enable such company to ensure compliance with applicable conditions under the NDI Rules;

iii.  the FPI is required to provide: (a) a clear intention to reclassify; and (b) all necessary approvals and concurrence etc. to their custodian. The custodian will accordingly, freeze the purchase transactions of such FPI in equity instrument of such Indian company till the completion of the reclassification. If the FPI is not able to procure the approvals and concurrence within the prescribed time, they would be required to mandatorily divest their holdings within the prescribed time;

iv.   in the event of reclassification, all reporting requirements of the holdings of such FPI must be in accordance with Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019:

a. Indian company: Form FC-GPR where investment beyond 10% is resulting from fresh issuance of equity instruments by an Indian company to such FPI;

b. FPI: Form FC-TRS where investment beyond 10% is resulting due to acquisition of equity instruments by such FPI in the secondary market; and

c. Concerned AD bank must report the amount of reclassified investments as divestment under LEC (FII) reporting;

v.    after the reporting mentioned in point (iv) above is completed, FPI is required to approach the custodian requesting the transfer of shares from its FPI demat account to its FDI demat account. Post completion of reclassification, the custodian will unfreeze the equity instruments and process the request. The date of breach of the investment limit should be considered as the date of reclassification; and

vi.   after reclassification, the entire investment of the FPI must be considered as FDI and should continue to be treated the same even if their investment eventually falls below 10%. Such reclassified FDI holdings would then be governed by Schedule I of the NDI Rules.