Regulatory Framework

Governing law
The objective of FDI policy issued by the Government is to invite and encourage foreign investments in India. Since 1991, the guidelines and the regulatory process have been substantially liberalized to facilitate foreign investments in India.
The Government issued a consolidated FDI Policy vide Circular 2 of 2010 dated 30 September 2010 effective from 1 October 2010. This Circular consolidates and subsumes all Press Notes, Press Releases, Clarifications issued on FDI policy as on 30 September 2010. The Government has also announced that it will issue a consolidated circular every six months to update the FDI policy.
The administrative and compliance aspects of FDI including the modes/instruments of Foreign Investments in an Indian Company
(e.g. Equity, Compulsorily Convertible Preference Shares, Compulsorily Convertible Debentures, American Depository Receipt (ADR)/Global Depository Receipt (GDR), etc) are embedded in the Foreign Exchange Regulations prescribed and monitored by the RBI.
The Foreign Exchange Regulation also contains beneficial schemes/provisions for investments by Non-Resident Indians (NRI)/
Person of Indian Origin (PIOs) within the overall framework/policy.
Apart from fresh investments in an Indian company, the FDI and Foreign Exchange Policy is also relevant for transfer of shares in an Indian Company between residents and non-residents. These are subject to detailed guidelines, valuation norms, compliances and approval requirements as stipulated.


Automatic Route Prior Approval Route(FIPB)
Investment in Sectors requiring prior Government approval.
Previous venture in India in the same field as stipulated.
FDI in excess of 24% for manufacturing items reserved for small scale sector.
Investment exceeding sectoral caps for Automatic Route to the extent permitted.

For the purpose of FDI in an Indian company, the following categories assume relevance:
– Sectors in which FDI is prohibited
– Sectors in which FDI is permitted

  • Investment under Automatic Route; and
  • Investment under Prior Approval Route i.e. with prior approval of the Government through the Foreign Investment Promotion Board (FIPB).

Automatic Route
Under Automatic Route there is no requirement of any prior regulatory approval but only post facto filing by the Indian Company to the RBI through Authorized dealer (Bankers) are required as under:

  • Filing an intimation, in the prescribed format, within 30 days of receipt of FDI in India including KYC norms; and
  • Filing prescribed form and documents within 30 days of issue of equity shares/equity convertible instruments to foreign investors. The equity shares/equity convertible instruments are required to be issued within 180 days from the receipt of application money.

FDI by a non-resident entity in an Indian Company in most of the business or commercial sectors now falls under the Automatic Route and very few cases require prior Government approval.

Prior Approval Route
FDI in the following activities or sectors generally requires prior approval of the Government/FIPB:

  • Proposals where the foreign collaborator has an existing financial or technical collaboration in India in the ‘same field’ prior to or as on 12 January 2005.
  • Proposals falling outside notified sectoral caps for Automatic Route but within the ceilings permitted under the Approval Route.
  • Proposals for FDI in sectors / activities in which FDI is permitted only under the Prior Approval Route.

Approval is granted by the FIPB on a case to case basis after examining the proposal for investment. Post FIPB approval, prescribed filings as applicable under the Automatic Route are also required to be carried out by the Indian Company under the Prior Approval Route.

Sectoral guidelines
The Annexure I provides an illustrative sectoral list for FDI falling under the Automatic Route, Prior Approval Route and prohibited list. These are revised on a regular basis by the Government depending upon the industry need.
The FDI is also subject to other relevant sectoral laws or regulations (e.g. banking industry which is governed by separate banking regulations, insurance industry which is governed by Insurance Regulatory and Development Authority, etc.).
Apart from above, for stipulated manufacturing/industrial activities by an Indian Company, the applicability and need for availing an industrial license under the Industrial Licensing Policy needs to be examined and complied with.

Discussion paper on FDI in Multi- Brand Retail Trading
The Government of India released a discussion paper on FDI in Multi-Brand Retail Trading for public comments. Currently, FDI in Multi-Brand retailing is prohibited in India while FDI in Single Brand Retailing permitted, to the extent of 51 percent under Prior Approval route and FDI in cash and carry wholesale trading is permitted, to the extent of 100 percent under the Automatic route.
The discussion paper outlines some key Issues for Resolution i.e. should FDI in multi-brand retail be permitted and if so, should a cap on investment be imposed and if so, what should this cap be, etc. The discussion paper has invited public comments in order to resolve these issues.

Discussion paper on FDI in the defence sector
The Government has released a discussion paper on FDI in the defence sector for public comments. The paper suggests for liberalisation of FDI cap in the Sector from 26 percent to 74 percent with the Approval Route i.e. with prior approval of the Government. The paper also outlines current policy, rationale and benefits arising out of the liberalisation proposed.

Discussion paper on FDI in Limited Liability Partnership (LLP)
The Government has released a discussion paper on FDI in LLP for public comments. The LLP form of business has not yet been recognized under FDI policy. The LLP structure lies between that of a company where FDI is permitted and that of a partnership, where it is generally not permitted. The discussion paper highlights the differences between a LLP and companies and partnerships. In the context of prescribing a regime for FDI in LLPs, the discussion paper highlights the issues in relation to induction of FDI in LLPs.

Issue and transfer of instruments and pricing guidelines
The Indian companies can issue the following equity shares/equity convertible instruments subject to sectoral caps, timelines and pricing norms as prescribed as under:

  • Equity shares;
  • Fully compulsorily and mandatorily convertible debentures;
  • Fully, compulsorily and mandatorily convertible preference shares
  • Foreign Currency Convertible Bonds (FCCB)
  • Depository Receipts (ADR and GDR)

Foreign investor can also invest in Indian companies by purchasing or acquiring existing shares/convertible instruments from Indian shareholders or from other non-resident shareholders.

Pricing guidelines
Any issue or transfer of equity shares/equity convertible instruments is subject to pricing or valuation norms. The pricing of the convertible capital instruments is required to be determined upfront at the time of issue/transfer of the instruments. In general, for listed companies, the pricing guidelines stipulate recourse to the Securities and Exchange Board of India (SEBI) Guidelines and for unlisted companies, as per the discounted free cash flow method except for rights issue and preferential allotment.

Previous venture conditions/criteria for FDI
These provisions apply only to a foreign investor with an existing venture or collaboration (technical and / or financial) with an Indian partner prior to or as on 12 January 2005 in a particular field and who is proposing to invest in another Indian company / joint venture in the ‘same field’ (as per relevant 4 digit 1987 NIC code) in India. In such cases of foreign investment, prior FIPB approval is required. Further, both parties are obliged to submit or demonstrate to the FIPB that the new venture does not prejudice the earlier venture. The prior FIPB approval is not required under the following circumstances:

  • Investment to be made by a venture capital fund registered with the SEBI.
  • Investments by Multinational financial institutions like Asian Development Bank, International Finance Corporation, Commonwealth Finance Corporation, etc.
  • Where, in the existing joint venture, investment by either of the parties is less than 3 percent.
  • Where the existing joint venture or collaboration is defunct or sick.
  • For issue of shares of an Indian company engaged in IT sector or mining sector, if the existing joint venture or technology transfer or trade mark agreement of the person to whom the shares are to be issued are also in the IT sector or in the mining sector for same area or mineral.

January 2005. In such cases, the joint venture agreements are expected to include a conflict of interest clause. This clause determines or safeguards the interests of both the joint venture partners in the event of one of the partner desires to set up another joint venture or a wholly owned subsidiary in the same field of economic activity.

Discussion paper on Approval of Foreign/Technical collaborations in case of existing ventures/tie ups in India
The Government has released a discussion paper on approval of Foreign/Technical collaborations in case of existing ventures/tie ups in India. The discussion paper suggests relaxation of the existing requirements to obtain a prior approval where the foreign investor has an existing joint venture or technology transfer/trademark agreement in the ‘Same’ field which has been in existence as on or prior to 12 January 2005.

Manufacturing items reserved for micro and small enterprises
Any industrial undertaking which is not a micro or small enterprise, but manufactures items reserved for the MSE sector would require prior FIPB approval where foreign investment is more than 24% in the equity capital. Such an undertaking would also require an Industrial License for such manufacture. The issue of Industrial License is subject to a few general conditions and the specific condition that the Industrial Undertaking shall undertake to export a minimum of 50 percent of the new or additional annual production of the MSE reserved items to be achieved within a maximum period of three years. The export obligation would be applicable from the date of commencement of commercial production.

External commercial borrowing/foreign currency convertible bonds/foreign currency exchangeable bonds
Overseas loans in foreign currency by Indian companies/entities from Foreign lenders are governed by the guidelines on External Commercial Borrowings (ECB) issued by the RBI under Foreign Exchange Regulations. The ECB Policy stipulates detailed guidelines for Eligible borrowers, recognized lenders, amount and maturity period, all-in-cost interest ceilings, end-use stipulations, compliances, etc.
Issue of any non-convertible, optionally convertible or partially convertible preference shares or debentures is considered as ECB from a foreign exchange regulation perspective and needs to comply with ECB guidelines.

An Indian company can also raise funds by issuing FCCBs. FCCB means a bond issued by an Indian company to non-residents in foreign currency, the principal and interest of which is payable in foreign currency. The FCCB are convertible into ordinary shares of the issuing company in any manner, either in whole, or in part.

Similarly, an Indian company can also raise funds through Foreign Currency Exchangeable Bonds (FCEBs). FCEB are similar to FCCBs except that in this case equity shares of another Indian Company (Offered Company – being a listed company, which is engaged in a sector eligible to receive FDI and eligible to issue or avail of FCCB or ECB) are issued on conversion. The issuer company should be part of the promoter group of the Offered company.

The policy for ECB is also applicable to FCCBs and FCEBs and accordingly all norms applicable for ECBs also apply to them as well.

American depositary receipts or global depositary receipts
A company can issue ADRs or GDRs if it is eligible to issue shares to person resident outside India under the FDI Policy subject to compliance with framework stipulated in this regard.
In general, Unlisted companies, which have not yet accessed the ADR or GDR route for raising capital, would require prior or simultaneous listing in the domestic market. Unlisted companies which have already issued ADR/GDR in the international market, have to list in the domestic market on making profit or within three years of such issue whichever is earlier.

Portfolio investment in India
FII who are eligible and apply / get registered with SEBI are eligible to invest in India under the Portfolio Investment Scheme (PIS) within prescribed guidelines, ceilings and parameters.
Eligible Institutional Investors that can register with SEBI as FIIs include, Pension Funds, Mutual Funds, Investment Trusts ,Banks, Charitable Societies, Foreign Central Bank, Sovereign Wealth funds, University Funds, Endowments, Foundations, Charitable Trusts Insurance Companies, Re-insurance Companies, Foreign Government Agencies, International or Multilateral Organisations/Agency, Broad based Funds, Asset Management Companies Investment Managers / Advisors Institutional Portfolio Managers and Trustee of a Trust.
Conceptually, an application for registration as an FII can be made in two capacities, namely as an investor or for investing on behalf of its sub-accounts.
Sub-account means any person resident outside India, on whose behalf investments are proposed to be made in India by a FII and who is registered as a sub-account under these regulations. Entities eligible to register as sub-account are Broad Based Funds, Broad Based Portfolios, Proprietary Funds of the FII, University Funds, Foreign Corporates, Endowments, Foundations, Charitable Trusts, Charitable Societies, Sovereign Wealth Funds and Foreign Individuals satisfying the prescribed conditions.

SEBI grants registration as FII based on certain criteria, namely constitution and incorporation of FII, track record, professional competence, financial soundness, experience, general reputation of fairness and integrity, being regulated in home country by appropriate foreign regulatory authority,, legal permissibility to invest in securities as per the norms of the country of its incorporation, fit and proper person, etc. SEBI grants registration to the FII and subaccount which is permanent unless suspended or cancelled by SEBI, subject to payment of fees and filing information every three years. The approval of the sub-account is co-terminus with that of the FII.
FIIs/sub-accounts can invest in Indian equities, debentures, warrants of companies (listed on recognized stock exchange or to be listed on a recognised stock exchange in India), units of a scheme floated by domestic mutual funds including Unit Trust of India, dated government securities, derivatives traded on a recognised stock exchange, commercial papers, security receipts and debt instruments within the ceiling/framework prescribed.
The FIIs can also access FDI route for investments in an Indian company.

Investment as foreign venture capital funds

A Foreign Venture Capital Investor (FVCI) which is eligible and registered with SEBI can invest in an Indian Venture Capital Fund/Indian Venture Capital Undertaking. It can also set up a domestic asset management company to manage the fund. All such investments are allowed under the Automatic Route subject to SEBI and RBI regulations and FDI Policy.

If the Indian/Domestic VCF is a registered Trust, then it seems prior Government approval may be required for foreign investment therein. FVCIs are also allowed to invest as non-resident entities in other companies subject to FDI Policy.

Investment by non-resident Indians
NRIs/PIOs can invest in the shares or convertible debentures of Indian company on repatriation basis on Indian stock exchange under PIS subject to limits and conditions.
NRIs/PIOs can also invest in the shares or convertible debenture of an Indian company (not engaged in sectors of in agricultural or plantation activities or real estate business or construction of farm houses or dealing in Transfer of Development Rights) on non-repatriation basis subject to conditions.
NRIs/PIOs are also eligible to invest in dated government securities, mutual funds, bonds, etc on repatriation and non-repatriation basis as per scheme/framework stipulated.

Calculation of total foreign investment
The FDI Policy also provides the methodology for calculation of Total Foreign Investment in an Indian Company for the purpose of sectoral cap and approval requirements. For this purpose all types of foreign investments i.e. FDI; FII holding as on 31 March; NRIs; ADRs; GDRs; FCCB; FCEB; fully, compulsorily and mandatorily convertible preferences shares; and fully, compulsorily and mandatorily convertible preferences shares are to be considered.
Total foreign investment is equal to Direct foreign investment plus indirect foreign investments in an Indian company.

  • Direct investment are all specified types of foreign investment directly by a non-resident entity into the Indian company
  • Indirect foreign investment are investments in an Indian company through investing Indian companies which are ‘owned or controlled’ by non-resident entities to be calculated as per the prescribed methodology.

These provisions are far-reaching in terms of scope, coverage, computation and go beyond the pro-rata methodology which was hitherto being applied in most cases.

There are detailed guidelines with respect to investment in ‘operating cum investing companies’ and ‘investment companies’.

The entry level guidelines or conditions for FDI in an Indian Company have been expressly clarified to extend to indirect foreign investment as well i.e. downstream investments by Indian entities owned and controlled by non-resident entities.
For the purpose of indirect investments, the Indian companies are categorised into

  • Only operating companies;
  • Operating-cum-investing companies;
  • Investing companies; and
  • Companies which do not have any operations in India and do not have any downstream investments.

For foreign investments in an Indian Investment company or which does not have any operation prior Government approval is required followed by notification has been stipulated.
For all cases of transfer of ownership or control of Indian companies in specified or controlled sectors from resident Indian citizens or entities to non-resident entities prior Government approval will be required.
For downstream investment by an operating-cum-holding company with foreign investment as stipulated, a notification to the Government is stipulated within the prescribed timeframe and parameters.
The investing companies cannot leverage funds from the domestic market for the purpose of downstream investment.

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