Recent Key Changes under the Foreign Investment Framework


By notification dated October 15, 2019, the Ministry of Finance brought into effect certain provisions of the Foreign Exchange Management Act, 1999 (‘FEMA’) which were originally introduced by the Finance Act, 2015. Prior to this notification, all capital account transactions were substantially regulated by the Reserve Bank of India (‘RBI’) which was also empowered to issue regulations in respect of the same. The amendments introduced by the Finance Act, 2015, which are now effective, recognize two categories of capital account transactions i.e. “capital account transactions involving debt instruments” and “capital account transactions involving non-debt instruments”, and the substantial powers to regulate the latter now vest with the Central Government whereas the RBI’s powers over the former remain largely unaffected. By extension, the Central Government is now empowered to notify ‘rules’ concerning non-debt instruments under Sections 46(2)(aa) and (ab) of FEMA which was also made effective by the same notification.

By notification dated October 16, 2019 (‘16 October Notification’), the Ministry of Finance further elaborated that inter alia (i) equity investments, (ii) capital participation in limited liability partnerships, (iii) instruments of investments recognized by the Foreign Direct Investment (‘FDI’) policy, (iv) investments in Alternative Investment Funds, Real Estate Investment Trusts and Infrastructure Investment Trusts, (v) equity tranche of a securitization structure, (vi) dealing in immovable property, (vii) contribution to trusts, and (viii) depository receipts issued against equity instruments, would all be considered as “non-debt instruments” for the purposes of FEMA and by exclusion, all other instruments would be deemed to be “debt instruments”.

Under this framework and in exercise of its powers under Section 46(2)(aa) and (ab) of FEMA, on October 17, 2019 the Central Government, through the Ministry of Finance, has issued the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (‘NDI Rules’) which supersede the earlier foreign investment regulations issued by the RBI (i.e. the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 (‘FEMA 20R’)) and the Foreign Exchange Management (Acquisition and Transfer of Immovable Property in India) Regulations, 2018.

By notification dated December 5, 2019, the Ministry of Finance has notified certain amendments to the NDI Rules which, among other things, addressed some oversights in the original text of the NDI Rules including incorporation of Press Note of 2019 dated September 18, 2019 (‘PN 4’). The NDI Rules, when initially notified, did not incorporate the changes made to the FDI policy pursuant to PN 4, such as liberalization of the conditions for single brand retail trading, clarifications regarding contract manufacturing and regulating streaming of news and current affairs through digital media.

Separately, the RBI has also notified the Foreign Exchange Management (Debt Instruments) Regulations, 2019 (‘FEMA DI Regulations’) (which supersedes FEMA 20R), and the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019 (‘FEMA Reporting Regulations’) consequent to the NDI Rules.

Some of the key changes to the foreign investment regulations framework pursuant to the above notifications are summarized below:

Part A:  NDI Rules and FEMA Reporting Regulations
Part B:  FEMA DI Regulations.


1.       Consultation with the Central Government: Under FEMA 20R, the RBI had the power to approve an investment which was not otherwise permitted. Under the NDI Rules, while this power remains with the RBI, it may be exercised only in consultation with the Central Government. Further, the RBI’s power to prescribe documentation and reporting requirements for certain transfers is also subject to consultation with the Central Government.

2.       Definition of “Listed Indian Company”: Under FEMA 20R, the definition of “listed Indian company” did not include “debt instruments”. However, the definition of “listed Indian company” has been amended to also include a company which has any of its debt instruments (in addition to its equity instruments) listed on a recognized stock exchange in India.

3.       Definition of “Hybrid Securities”: A new definition of “hybrid securities” has been introduced, which means hybrid instruments including optionally or partially convertible preference shares or debentures or such other instruments as specified by the Central Government from time to time, which can be issued by an Indian company or a trust to a person resident outside India. While this term has not been used in the NDI Rules, the Foreign Exchange Management (Borrowing and Lending) Regulations, 2018 do state that certain hybrid instruments, such as optionally convertible debentures, presently covered under the external commercial borrowings rules, will be governed by specific hybrid instruments regulations when notified by the Government of India. While not used, the inclusion of this term could suggest that investments by way of hybrid instruments could come to be regulated under the NDI Rules. It should be noted that FEMA 20R only recognized fully and mandatorily convertible instruments under the FDI route and instruments such as optionally or partially convertible securities are regulated as debt.

4.       Prohibited Sectors – General: Under FEMA 20R, there was ambiguity on whether foreign portfolio investment was permitted in prohibited sectors (such as lottery, gambling and casinos, chit funds and manufacturing of cigarettes). The NDI Rules clarify that investment by foreign portfolio investors (‘FPIs’) is permitted in such sectors up to 24%.

5.       Definition of “E-commerce entity”: As per FEMA 20R, an “e-commerce entity” was defined to mean: (i) a company incorporated under the Companies Act 1956 / 2013; (ii) a foreign company as per the Companies Act, 2013; or (iii) an office, branch or agency in India under Section 2(v)(iii) of FEMA which is owned or controlled by a person resident outside India and conducting e-commerce business. The revised definition in the NDI Rules has curtailed the ambit of the definition, and encompasses only “a company incorporated under the Companies Act 1956 or the Companies Act, 2013”.

6.       Transfer of Equity Instruments between Non-Residents: The NDI Rules clarify that where a non-resident transfers equity instruments held on a non-repatriation basis to a non-resident who intends to hold them on a repatriation basis, then such transfer is required to be in compliance with applicable conditions such as sectoral caps, pricing guidelines and reporting requirements for such transfers, as may be specified by the RBI.

7.         Changes Related to Investments by FPIs:

(i)        Investment in “to be listed” Equity Instruments: Under FEMA 20R, the definition of “listed Indian company” did not include the term “to be listed”. However, NDI Rules now permit  FPIs to purchase or sell equity instruments of an Indian company which are listed or to be listed on a recognized stock exchange in India. This position is now aligned with the SEBI (Foreign Portfolio Investment) Regulations, 2019.

(ii)     Aggregate Limit: Until March 31, 2020, the total holdings of all FPIs put together (including any other direct and indirect foreign investments in the Indian company permitted under the NDI Rules) in an Indian company is not permitted to exceed 24% of the paid-up equity capital on a fully diluted basis or paid up value of each series of debentures or preference shares or share warrants (except if the ceiling has been raised to sectoral cap or statutory ceiling by the board and shareholders of the company). This is in line with the framework that was prescribed under FEMA 20R.

Under the NDI Rules, from April 1, 2020 the aggregate limit will automatically be deemed to be the sectoral cap as contained in the NDI Rules, without the requirement to pass any board or shareholders resolutions. The aggregate limit can be decreased by the Indian company to a lower limit of 24%, 49% or 74% as deemed fit, with the approval of its board and shareholders (by way of a special resolution), before March 31, 2020. Similarly, where an Indian company has decreased its aggregate limit as mentioned above, it may increase such aggregate limit to 49% or 74% or the sectoral cap or statutory ceiling as deemed fit, with the approval of its board and shareholders (by way of a special resolution). However, once the aggregate limit has been increased, the Indian company cannot reduce it to a lower threshold.

(iii)     Breach of FPI limits: If the total holding of an FPI (including its FPI investor group) breaches the prescribed limit of investing below 10% of the total paid-up equity capital on a fully diluted basis or below 10% of the paid-up value of each series of debentures or preference shares or share warrants issued by an Indian company, the FPI will be required to either divest the excess holdings within five trading days from the date of the breach or have its entire investment in the company treated as FDI. Such FPI and its investor group will also not be permitted to make any further portfolio investments in the concerned company. The period between the breach of the prescribed limit and the divestment or conversion to FDI within the prescribed time will not be treated as a violation of the NDI Rules. Previously, under FEMA 20R, the requirement was to sell down the position within five trading days, without further implications such as prescribing of further investments.

(iv)     Investment in Other Instruments: Permission has now been given to FPIs to invest on repatriation basis in: (a) Category III Alternative Investment Funds, (b) offshore funds for which no-objection certificate has been issued under the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996 and which invest more than 50% in equity, and (c) units of Real Estate Investment Trusts and Infrastructure Investment Trusts. Such permission is subject to the terms and conditions prescribed by the RBI and / or the Securities and Exchange Board of India (as applicable).

(v)       Foreign Investment either as FPI or FDI: NDI Rules provide that going forward a person resident outside India may hold foreign investment either as FDI or as FPI in any particular Indian company.

8.       Investments in Domestic Mutual Funds: Previously, FEMA 20R governed investments by non-resident Indians (‘NRIs’) and Overseas Citizens of India (‘OCIs’) in domestic mutual funds. However, going forward, investment by NRIs and OCIs in domestic mutual funds which invest more than 50% in equity will be governed by the NDI Rules, while investment by NRIs and OCIs in domestic mutual funds which invest less than or equal to 50% in equity will be governed by the FEMA DI Regulations.

9.        Refund of Consideration: Under FEMA 20R, prior approval of the RBI was required for payment of interest (as mandated by the Companies Act, 2013) on delay of refund of consideration if capital instruments are not issued within 60 days from receipt of consideration. Under the FEMA Reporting Regulations, this requirement has been omitted.

10.      Clarification regarding Investments in Non-Operating Companies: An Indian company which does not have any operations and has not made any downstream investment that is treated as indirect foreign investment for the investee entity may receive foreign investment under the automatic route subject to its proposed activity being under automatic route and without FDI linked performance conditions. FEMA 20R did not contain the clarificatory phrase “that is treated as indirect foreign investment for the investee entity”.


1.       Purchase and Sale of Debt Instruments: The term ‘debt instruments’ has been defined to mean instruments listed under Schedule I of the FEMA DI Regulations. While Schedule I does not have a general list of instruments, it separately specifies the instruments in which investment can be made by FPIs, NRIs and OCIs on repatriation and non-repatriation basis. Schedule I of the FEMA DI Regulations substantially corresponds to Part A to D of Schedule 5 of the FEMA 20R, which governed investments by FPIs, NRIs and OCIs in non-equity instruments such as non-convertible debentures, treasury bills, etc. However, the 16 October Notification defines debt instruments as (i) Government bonds; (ii) corporate bonds; (iii) all tranches of securitisation structure which are not equity tranche; (iv) borrowings by Indian firms through loans; (v) depository receipts whose underlying securities are debt securities; and (vi) all other instruments which are not specified in the 16 October Notification as non-debt instruments or debt instruments.

2.       Some of the key changes between Schedule 5 of FEMA 20R and the FEMA DI Regulations are noted below:

(i)      Purchase and Sale of Debt Instruments by FPIs, NRIs & OCIs:

a.       New Instrument: FPIs, NRIs and OCIs are now permitted to invest in debt instruments issued by banks which are eligible for inclusion in regulatory capital, as against the previous entitlement of investment in perpetual debt instruments eligible for inclusion as Tier I capital and debt capital instruments as upper Tier II capital issued by banks in India to augment their capital.

b.       Omission: Any certificate or instrument issued and listed in terms of the SEBI (Regulations on Public Offer and Listing of Securitised Debt Instruments), 2008 is no longer available for investment by FPIs. NRI or OCIs are no longer permitted to invest, on repatriation basis, in shares of public sector enterprises being disinvested by the Central Government. Further, only bonds and not units issued by Infrastructure Debt Funds are now permitted for investment by NRIs and OCIs.

(ii)     Purchase of Debt Instruments by NRIs / OCIs on Non-Repatriation Basis: While NRIs and OCIs are permitted to invest in units of domestic mutual funds or exchange traded funds (as discussed above), units of money market mutual funds are no longer included as permissible debt instruments for investment by NRIs or OCIs on non-repatriation basis.

(iii)    Multilateral Development Banks: Previously, a multilateral development bank which was specifically permitted by the Government of India to float Rupee bonds in India was entitled to purchase Government dated securities. This requirement has been removed and now a foreign central bank or a Multilateral Development Bank or any other entity permitted by the RBI, is eligible to purchase or sell dated Government Securities / treasury bills, as per terms specified by the RBI.

Date: February 7, 2020