Fema tweaks on the cards to allow FPIs to seamlessly access FDI route

This move comes in response to several requests from foreign investors seeking to simplify the reporting requirements they currently face when exceeding the 10 per cent threshold

The government is planning to introduce legislative changes to the Foreign Exchange Management Act (Fema) regulations, with a focus on easing the pathway for inflows from a foreign portfolio investor to transition seamlessly into foreign direct investments (FDI) once the FPI surpasses the 10 per cent ownership threshold in a company.

This move stems from multiple requests by foreign investors seeking to streamline the reporting requirements that arise when their stakes in Indian firms cross the 10 per cent mark.

“Currently, Fema has ‘watertight regulations’ that restrict an FPI from buying more than 10 per cent as a strategic investor in a single company,” a senior government official told Business Standard. “At the same time, FDI rules allow for up to 100 per cent investment in many sectors.”

The official noted that the Department of Economic Affairs (DEA) is working on resolving key concerns to address the challenges faced by such foreign investors.

Among the issues flagged are ambiguities surrounding the shift from FPI to FDI. Custodians, for example, are currently required to open separate security and depository accounts when an investment is reclassified, the official said, leading to reporting complexities and potential mismatches.

Further, tax treatment upon conversion to FDI remains unclear, creating uncertainty for investors. Corporate actions during the conversion process from FPI to FDI pose their own set of hurdles, too, necessitating a relook at the existing framework.

Uncertainty also surrounds the designation of the designated depository participant (DDP) under the multiple investment manager (MIM) structure, especially in cases where more than one DDP is involved.

“These issues underscore the need for clarity and guidance to facilitate a smooth transition from FPI to FDI,” the official said.

Discussions are already underway on simplifying procedures and aligning FPI regulations more closely with FDI norms, he said.

Current rules stipulate that FPIs breaching the 10 per cent limit have the option to divest their excess holdings within five trading days from the date of settlement. Should they choose not to divest, the entire investment by the FPI and its investor group is classified as a foreign direct investment, effectively prohibiting further portfolio investment in the company in question.

In such cases, the FPI’s designated custodian must notify depositories and the company involved, so the necessary changes can be reflected in their records within seven trading days from the date of settlement of the trades causing the breach.

Reclassification of an FPI’s holdings as FDI, as well as divestment of excess shares, shall be subject to additional conditions as specified by the Securities and Exchange Board of India (Sebi) and the Reserve Bank of India (RBI). Notably, any breach of the aggregate or sectoral investment limit during the interim period — between the acquisition and subsequent sale or reclassification to FDI — will not be deemed a violation of rules.

Union Finance Minister Nirmala Sitharaman, in her latest Budget speech, underscored the government’s intent to simplify FDI and overseas investment rules. Earlier this month, the DEA introduced a series of changes to Fema regulations, including the relaxation of cross-border share swap rules.

The move aims to support the global expansion of Indian businesses by enabling smoother mergers, acquisitions, and strategic alliances with international partners.

OPENING THE GATES
 

- A foreign portfolio investor (FPI) can currently buy up to 10% stake in a listed company
 

- For transitioning from FPI to making foreign direct investment, custodians need to open separate security and depository accounts upon reclassification
 

- This poses reporting complexities, and potential mismatches
 

- Tax treatment after conversion to FDI remains unclear, creating uncertainty for investors