New FDI Regulations – Key Changes Impacting Stakeholders

The Reserve Bank of India (“RBI”) vide its notification dated November 7, 2017 has taken another step to simplify one of the most seminal regulations governing foreign investment in India namely Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2017 (“New FEMA Regulation”). Summarized below are key changes introduced by the New FEMA Regulation which may have lasting impact on the various stakeholders.

1. Capital Vs Capital Instruments - anomaly removed. Under Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 (“Erstwhile FEMA Regulation”) the term ‘capital instrument’ was not defined. Instead, the Erstwhile FEMA Regulation referred to the term ‘capital’ which always meant equity shares, preference shares, convertible preference shares and convertible debentures, however, excluded share warrants from its ambit. On the other hand, the Consolidated FDI Policy of 2017 issued by Department of Industrial Policy and Promotion, Government of India on August 28, 2017 (“FDI Policy”), included ‘warrants’ as part of definition of term ‘capital’. Therefore, some sort of uncertainty prevailed in usage of term ‘capital’. The New FEMA Regulation has overcome this anomaly by expressly defining the term ‘capital instruments’ including the term ‘share warrants’ issued by an Indian company within the said definition.
2. Can share warrants be issued by only listed companies to a foreign investor? The Erstwhile FEMA Regulation and FDI Policy, had suggested an inclusive definition of ‘warrant’ which always meant share warrants issued by an Indian company in accordance with the provisions of the Companies Act, 2013. However, the New FEMA Regulation defines the term ‘share warrants’ to mean those issued by an Indian company in accordance with the regulations issued by the Securities and Exchange Board of India (“SEBI”). Interestingly, SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 governs the issuance of share warrants issued or to be issued by listed Indian companies. Therefore, going by the stricter interpretation of the definition of ‘share warrants’ as referred in the New FEMA Regulation, it appears that now only listed Indian companies may issue share warrants to a person resident outside India or non-resident. A clarification on this aspect of new law by RBI may be warranted.
3. FDI Vs FPI – Reclassification. One of the most pivotal change brought out by the New FEMA Regulation is the distinction laid out between the type of investment made by non-resident namely Foreign Direct Investment (“FDI”) and Foreign Portfolio Investment (“FPI”), a change suggested in Dr. Arvind Mayaram Committee’s report in June 2014. The said report characterized FDI as sort of lasting interest or a long term relationship having significant degree of influence. The said report suggested that typically, ownership of 10 percent or more of the ordinary shares / voting power signifies this relationship. On the other hand, FPI is characterized by portfolio investment that is distinctive from FDI because of the nature of the funds raised, representing largely anonymous relationship between the issuers and holders, and the degree of trading liquidity in the instruments.New FEMA Regulation has implemented the key recommendations made in the said report. The New FEMA Regulation now defines the term ‘FDI’ to mean investment through capital instruments by non-resident (i) in an unlisted Indian company; or (ii) in 10% or more of the post issue paid up equity capital on a fully diluted basis of a listed Indian company. However, the said definition is prospective in nature and does not apply to existing FDI investments which do not meet the 10% threshold as per the aforesaid definition. On the other hand, term ‘FPI’ has now been defined to mean any investment made by non-resident through capital instruments only pertaining to listed Indian companies and where such investment is less than 10% of the post issue paid-up share capital on a fully diluted basis or less than 10% of the paid up value of each series of capital instruments of such listed Indian company.Therefore, in case of a listed Indian company, if the foreign investment is made within the aforesaid limit of less than 10% then, the said investment will be termed as FPI and if the said foreign investment exceeds to 10% or more then, the same FPI will be re-classified as FDI and all provisions as applicable to FDI will be applicable on such foreign investment including the reporting requirements as applicable to an Indian company for FDI investment in FC-GPR. Therefore, it appears that non-resident may hold foreign investment in a particular Indian company either as FDI or FPI (but not both). Conversely, it also suggests that FDI investor who proposes to invest less than 10% in a listed Indian company can make such investment only as FPI investor and thereby it may need to seek FPI registration with SEBI before making such investment. A clarification on this aspect of new law by RBI is desirable.
4. Can right shares be issued by an unlisted Indian company to a non-resident without any Pricing Guidelines? Under the Erstwhile FEMA Regulation, the only requirement for the price at which rights issue was to be made to a non-resident was that the same should not be less than the price at which rights issue was made to a resident. Thus, technically shares could be issued to a person resident in India or resident at a nominal price and thereby to a non-resident at nominal price and therefore, as a market practice rights issue to non-residents was never subject to any pricing guidelines (i.e. share issuance at a price which is determined by internationally accepted pricing methodology between unrelated parties). Under the New FEMA Regulation, the said exception to the pricing guidelines has now been made limited to a non- resident who is an existing investor in the issuer company. It appears that the renunciation of rights in favour of a non-resident who proposes to subscribe the rights share, has to be an existing shareholder for claiming exemption from the applicability of pricing guidelines. Thus, a non-resident (who is not an existing investor in the issuer company) and is making first time investment in such unlisted Indian company, may not seek exemption from the applicability of pricing guidelines in case of rights issue.
5. Whether interest of CCDs can be paid without any cap / limit? The Erstwhile FEMA Regulation had prescribed a cap of 300 basis points over the SBI Prime Lending Rate with respect to the payment of dividend on the preference shares issued to non-residents. As per the prevailing market practice interest payable to the non-residents on convertible debentures issued to them by an Indian company was subject to the similar cap / limit. The New FEMA Regulation does not prescribe any such limit on the payment of dividend on preference shares now. This gives flexibility to the companies for deciding the rate of dividends or interest to be paid by them to the non-residents and may also act as one of the key incentives in structuring future foreign investments in convertible equity and debt instruments.
6. Late submission fee instead of compounding in case of delays in reporting. New FEMA Regulation stipulates payment of late submission fee in case of any delay in reporting thus removing the compounding of such late submissions by the RBI. Compounding application with RBI has always been time consuming and tedious exercise. This could be seen as one of a major relief from compliance perspective for most of the Indian companies.
7. Timeline for issuance of capital instruments aligned with the Companies Act, 2013. The Erstwhile FEMA Regulation prescribed time period of 180 days for the purpose of allotment of eligible instruments, whereas, the time period prescribed under the Companies Act, 2013 has been provided as 60 days. The said inconsistency has been amended in the New FEMA Regulation, wherein, the allotment time period for capital instruments has been aligned with the Companies Act, 2013 (i.e., 60 days).It will be interesting to see the impact of these regulatory changes in practice.