The Reserve Bank of India closely monitors each and every investment made in the Indian economy from Foreign investors. For every investment, the Authorised Bank and Investors are required to file proper documents with the RBI on a frequent basis. If any investment is made in contravention of the provisions given, the applicable penalty shall be imposed on the investor.
In a similar line, RBI has issued the operation framework vide circular No. RBI/2024-25/90 dated 11th November 2024, for reclassification of foreign portfolio Investment (FPI) where investment made by FPI is beyond the permitted limit.
1. Investment threshold Limit for Foreign Portfolio Investors (FPI)
- As per Schedule II of Foreign Exchange Management (Non-Debt Instrument) Rules, 2019, Foreign Portfolio Investors are allowed to invest, along with their Investor group, less than 10% of total paid-up equity capital on a fully diluted basis.
2. Consequences of Investment made by FPI beyond the specified limit
- As per Para 1(a)(iii) of Schedule II of FEM (NDI) Rules, If FPI investing in breach of the prescribed threshold limit then he shall have the following options:
- To Divest their holding within 5 trading days from the date of settlement of the trade causing the breach; or
- If FPI Chooses not to divest then reclassify their holding as Foreign Direct Investment (FDI) from Foreign Portfolio Investment (FPI). In such case, the entire investment made in the company by such FPI and its investor group shall be considered as an investment under FDI, and the FPI and its investor group shall not make further portfolio investment in the company concerned
- RBI has issued a detailed operational framework of the manner of reclassification of their investment from FPI to FDI.
- The operational framework shall come into effect immediately.
3. Difference Between FDI and FPI
The key difference between FDI and FPI is the intent of the Investment. Foreign Direct Investment is done with the intent of obtaining control over the entity and earning profits through business growth. Whereas, Foreign Portfolio investment is done for the purpose of getting returns by way of interest and regular market fluctuation. FPI does not have any intention of getting control over the entity.
FDI is an investment made in a business entity and is generally intended for a long-term period whereas FPI is a short-term or medium-term investment.
4. Process of reclassification of Investment from FPI to FDI
The FPI shall be following the following process for the reclassification of investment:
a. Obtain Approval and Concurrence
The FPI comply with the following conditions before intending to acquire equity instruments beyond the prescribed limit:
- Obtain necessary approvals from the Government, as applicable, including approvals required in case of investment from land bordering countries.
- The FPI shall make sure that the acquisition beyond the prescribed limit is made by the provisions applicable to FDI. Therefore, FPI should adhere to entry route, sectoral caps, investment limits, pricing guidelines, and other attendant conditions for FDI;
- Obtain concurrence of the Indian investee company concerned for reclassification of the investment to FDI to enable such company to ensure compliance with conditions about sectors prohibited for FDI, sectoral caps, and government approvals, wherever applicable, under the Rules.
The facility of reclassification shall not be permitted in any sector prohibited for FDI.
b. Furnish information to the custodian and freeze the purchase transaction by FPI
- The FPI shall clearly articulate its intent to reclassify existing FPI held in a company into FDI and shall provide a copy of the necessary approvals and concurrence to its Custodian.
- Upon receipt of information from FPI, The Custodian shall freeze the purchase transactions by such FPI in equity instruments of such Indian company, till completion of the reclassification.
c. Consequences of not obtaining approval
Where the necessary prior approvals or concurrence have not been obtained by the FPI, the investment beyond the prescribed limit shall be compulsorily divested within the prescribed time.
d. Reports to be furnished for reclassification
For reclassification, the following reports shall be submitted within the prescribed time limit:
| Reporting Person | Form | Requirement |
| Indian Company | FC-GPR | where the investment beyond the prescribed limit is due to the acquisition of equity instruments by such FPI in the secondary market. |
| FPI | FC-TRS | where the investment beyond the prescribed limit is due to acquisition of equity instruments by such FPI in the secondary market. |
| AD Bank | LEC (FII) | AD bank concerned shall report the amount of reclassified foreign portfolio investment as divestment under the LEC (FII) reporting. |
e. Completion of reclassification
- Post completion of reporting requirements, the FPI shall approach its Custodian for transferring the equity instruments of the Indian company from its demat account maintained for holding FPI to its demat account maintained for holding FDI.
- After ensuring that the reporting for reclassification is complete in all aspects, the custodian shall unfreeze the equity instruments and process the request.
- The date of breach shall be considered the date of reclassification.
- Thereafter, the entire investment of the FPI shall be considered as FDI and shall continue to be treated as FDI even if the investment falls to a level below 10% subsequently.
- The FPI along with its investor group shall be treated as a single person for the purpose of reclassification of foreign portfolio investment.
- Post completion of reclassification purpose, the investment shall be governed by the provisions of FDI.
Conclusion
The Reserve Bank of India in consultation with SEBI has finalized the process of reclassification of Foreign Portfolio Investment (FPI) to FDI where the investment in FPI is made beyond the specified limit. These operational frameworks shall help the investor to smoothly carry out the process of conversion. If FPI does not intend to convert the FPI to FDI then they have to make sure that the excess investment is divested within 5 trading days from the date of settlement of the trades that have caused the breach.
