The Reserve Bank of India (RBI) on Monday introduced a simplified operational framework to allow foreign portfolio investors (FPIs) to convert their investments into foreign direct investments (FDI) when shareholdings in Indian companies exceed the prescribed limit of 10 per cent. .

This regulatory change addresses scenarios where an FPI, along with its group of investors, inadvertently crosses the threshold, thereby providing a structured pathway to retain investment in compliance with Indian FDI guidelines.

According to current regulations, REIT can hold a maximum of 10% of the total paid-up share capital of an Indian company. Exceeding this ceiling previously left FPIs with two choices: sell excess shares or reclassify them as FDI. The RBI’s new framework requires that this reclassification be finalized within five trading days of the transaction exceeding the limit, subject to the approval of the Government of India and the investee company.

Reclassification will be prohibited in sectors where FDI is restricted.

To ensure compliance, the RBI requires full reporting under the Foreign Exchange Management (Mode of Payment and Reporting of Instruments Other Than Debt) Regulations, 2019. After fulfilling these reporting obligations, the FPI must direct its depositary to transfer the equity instruments of its REIT. -demat account designated to an account created specifically for FDI holdings.

Jyoti Prakash Gadia, managing director of Resurgent India, a financial advisory firm, said the RBI framework brings clarity and transparency, especially as FPIs strive to meet the 10% cap on equity released.

He emphasized that this guidance applies exclusively to sectors in which FDI is permitted, thereby ensuring that the specific approval and limit requirements of each sector remain intact. “The operational framework announced by RBI is therefore essentially to provide guidance to FPIs while opting for reclassification from FPI to FDI so that appropriate compliances are ensured without any dilution of the basic structure of the FDI regime and prescribed rules in this regard.”

This move by the RBI complements a similar update by the Securities and Exchange Board of India (Sebi), which had revised its own guidelines for reclassification of FPIs as FDI.

Effective May 30, 2024, Sebi’s procedures require FPIs to comply with the Foreign Exchange Management Act (FEMA) and other relevant regulations when opting for reclassification. Sebi requires that once an FPI crosses the 10% equity threshold, it can opt to convert its holdings into FDI, provided it meets all regulatory criteria.

According to Sebi’s revised guidelines, any FPI opting for reclassification must inform its custodian, who will freeze any further share transactions in the company until the conversion process is completed. The custodian will then facilitate the transfer of the securities to the designated FDI account, ensuring compliance with all reporting requirements.