Introduction
By way of notification dated 16.08.2024, the Ministry of Finance (MoF) has amended the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (‘NDI Rules’) vide the Foreign Exchange Management (Non-debt Instruments) (Fourth Amendment) Rules, 2024 (‘Amendment Rules’) with effect from the date of the notification[i]. These changes introduce new provisions and modify existing ones, aligning with evolving economic and regulatory needs, particularly concerning foreign investment in India.
Background of NDI Rules, 2019
The NDI Rules were established to regulate foreign exchange transactions related to non-debt instruments, such as equity investments. Introduced under the Foreign Exchange Management Act, 1999, these rules replaced older regulations to streamline and modernise foreign investment practices in India. Key aspects of these rules include the regulation of foreign direct investment (‘FDI’) across various sectors, specifying sectoral caps and setting conditions for investment. They also classify different types of foreign investments, such as FDI, foreign portfolio investment (‘FPI’), and investments by non-resident Indians (‘NRIs’) and overseas citizens of India (‘OCI’). The rules outline the entry routes for foreign investment, distinguishing between automatic routes, which do not require government approval and government routes, which do. Additionally, the rules address foreign exchange transactions related to equity instruments, including provisions for share swaps, repatriation of profits and guidelines for downstream investments.
Key Amendments
1. Introduction of Rule 9A: Equity Instrument and Equity Capital Swap:
The Amendment Rules insert a new rule, Rule 9A, titled ‘Swap of equity instruments and equity capital.’ This provision facilitates the transfer of equity instruments of an Indian company between a resident (a person resident in India) and a non-resident (a person resident outside India) through an equity instrument swap.
Equity Instrument Swap: This rule allows residents and NRIs to exchange equity instruments, subject to compliance with rules prescribed by the central government and regulations specified by the Reserve Bank of India (‘RBI’).
Equity Capital Swap: It also covers the swap of equity capital of a foreign company, ensuring that such swaps comply with the Foreign Exchange Management (Overseas Investment) Rules, 2022, and RBI regulations. This broadens the scope for cross-border equity transactions and offers more flexibility in structuring investments.
Government Approval Requirement: The rule mandates that prior government approval must be obtained in cases where such approval is applicable. This ensures that the government retains oversight in sensitive or strategically important transactions.
2. Definition of ‘Control’
The amendment clearly defines ‘control’ within the contexts of both companies and Limited Liability Partnerships (‘LLPs’). This definition is crucial as control is a key determinant in assessing ownership, management influence and regulatory compliance in domestic and cross-border transactions.
For Companies: ‘Control’ will now have the same meaning as assigned to it in the Companies Act, 2013. This typically involves the power to direct a company's management and policies, whether through ownership of voting securities, by contract, or otherwise.
For LLPs: In the case of LLPs, ‘control’ refers to the right to appoint the majority of designated partners, where these partners have control over all the policies of the LLP, specifically excluding others. This clarification aligns with the unique structure and governance framework of LLPs.
3. Updated Definitions and Clauses:
Several existing clauses and definitions have been updated to reflect current practices and regulatory requirements:
Definition of Startup Company: The amendment updates the definition of a ‘startup company’ to align with the criteria set by the Department for Promotion of Industry and Internal Trade, Ministry of Commerce and Industry. A startup company must be a private company incorporated under the Companies Act, 2013 and recognised as a startup under the government of India’s (GOI) notification, as amended from time to time.
FPI: The rules have been clarified to state that foreign portfolio investments up to the sectoral or statutory cap do not require government approval or compliance with sectoral conditions unless such investment results in a transfer of ownership or control of a resident Indian company from Indian citizens to NRIs. This amendment aims to streamline the FPI process and ensure clarity in cases where government approval is or isn’t required.
4. Sectoral Cap for White Label ATM Operations (‘WLAO’):
The amendment also introduces a new sectoral cap and conditions for WLAO :
100% FDI Under Automatic Route: The rules now allow for 100% FDI in WLAOs under the automatic route. This means foreign entities can invest in WLAOs without prior government approval, provided they meet certain conditions.
Minimum Net Worth Requirement: Any non-bank entity intending to set up WLAO must have a minimum net worth of Rs. 100 crores as per the latest financial year’s audited balance sheet. This net worth must be maintained at all times.
Compliance with Other Financial Services: If the entity is also involved in other financial services, the foreign investment in the WLAO must comply with the applicable minimum capitalisation norms for those services. FDI in WLAOs will also be subject to specific criteria and guidelines issued by the RBI under the Payment and Settlement Systems Act, 2007.
5. Clarifications and Omissions:
The amendment further clarifies certain provisions and omits outdated ones to remove ambiguity:
Indirect Foreign Investment: The amendment clarifies that investments made by an Indian entity owned and controlled by a NRI or an OCI on a non-repatriation basis shall not be considered for calculating indirect foreign investment.
Common Ownership of FPIs: It also clarifies that if two or more FPIs, including foreign governments or related entities, have common ownership or control exceeding 50%, they will be treated as part of a single investor group.
Our Analysis
These amendments aim to enhance flexibility in cross-border transactions, potentially attracting more foreign investment and aligning India with global practices. However, the requirement for prior government approval in certain cases could slow down the transaction process, adding to the compliance burden for companies. The definition of control, while providing clarity, might increase complexity and lead to potential legal disputes, especially in layered ownership structures. Additionally, the amendment's provisions on foreign portfolio investments could introduce more regulatory scrutiny, which might deter some investors. Despite these concerns, the amendments represent a step forward in modernising India’s foreign investment regulations, balancing investor friendliness with the need to protect strategic national interests.
End Note
[i] Notification S.O. 3492(E) [F. NO. 1/8/2024-EM].
Authored by Muskaan Jain, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinions.