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The Ministry of Finance, on October 15, 2019, notified Sections139, 143 and 144 of the Finance Act, 2015 which had proposedcertain amendments to Section 6 (Capital AccountTransaction), Section 46 (Power of Central Government tomake rules) and Section 47 (Power of RBI to makeregulations) respectively, of the Foreign Exchange ManagementAct, 1999.
These amendments have, inter alia, resulted in a powershift from the RBI to the Central Government, enhancing thelatter's involvement in the foreign exchange transactions. Abifurcation of instruments into debt instruments and non-debtinstruments has been introduced and while the RBI (inconsultation with the Central Government) is assigned theresponsibility to draft regulations for debt instruments, theCentral Government (in consultation with the RBI) isentrusted with the power to frame rules for non-debt instruments.It is however interesting to note that the Central Government isempowered to determine which all instruments would be classified asthe debt instruments.
Exercising the above power, the Central Government notified theForeign Exchange Management (Non-Debt Instruments) Rules,2019 ("NDI Rules") on October17, 2019 superseding the erstwhile Foreign Exchange Management(Transfer of Issue of Security by a Person Resident outsideIndia) Regulations, 2017("TISPRO") and the ForeignExchange Management (Acquisition and Transfer of ImmovableProperty in India) Regulations, 2018.
Further, to put things into perspective, the RBI also notifiedthe Foreign Exchange Management (Debt Instruments)Regulations, 2019 superseding TISPRO, and the Foreign ExchangeManagement (Mode of Payment and Reporting of Non-DebtInstruments) Regulations, 2019, which provides for reportingrequirements in relation to any investment made under the NDIRules.
As a most recent development, the Central Government hasnotified the Foreign Exchange Management (Non-DebtInstruments) (Amendment) Rules, 2019("Amendment Rules") on December5, 2019. These Amendment Rules, inter alia, primarilyincorporates the provisions of the Press Note 4 of 2019, recentlyannounced by the Department for Promotion of Industry and InternalTrade ("PN4"), which were notreflected in the NDI Rules.
While there has not been a drastic revamp of foreign investmentregime, we have discussed below some of the key changes that comeforth with the NDI Rules read with Amendment Rules.
- Key changes in thedefinitions:
- Debt and Non-DebtInstruments: The NDI Rules provide for an exhaustive listof instruments as 'non-debt instruments' and defines'debt instruments' as all instruments falling outside thecategory of non-debt instruments. This needs to be read along withthe list of debt instruments and non-debt instruments notified bythe Central Government on October 16, 2019.
- Equity Instruments:The NDI Rules replaced the term 'Capital Instruments' inTISPRO with 'Equity Instruments'.
- Hybrid Securities:The NDI Rules introduced the concept of Hybrid Securities asoptionally or partially convertible preference shares or debenturesor any other such Government specified instruments, which can beissued to a person resident outside India.
However, the term Hybrid Securities has not been used anywherein the NDI Rules.
- Investment Vehicle:The definition of Investment Vehicle under TISPRO was amended bythe NDI Rules to include mutual funds which invest more than 50% inequity governed by the SEBI (Mutual Funds) Regulations,1996. The same has been deleted by Amendment Rules and theerstwhile definition of the Investment Vehicle under TISPRO hasbeen restored.
- Sector specificchanges
- E-Commerce: The NDIRules has limited the purview of E-Commerce entities to companiesincorporated under the Companies Act, 1956 or the Companies Act,2013, conducting e-commerce business and it no longer includes aforeign company or an office, branch or agency in India, owned orcontrolled by a person resident outside India, conducting thee-commerce business.
Further, the Amendment Rules has inserted a condition thate-commerce marketplace entity with FDI shall have to obtain andmaintain a report of statutory auditor by September 30 of everyyear for the preceding financial year confirming compliance of thee-commerce guidelines. This would ensure compliances of the FDIPolicy in the e-commerce sector.
- Other Sectors: Theliberalised FDI norms in the sectors of coal mining, contractmanufacturing, single-brand retail trading (SBRT) and digitalmedia, as announced vide PN4, have been incorporated inthe NDI Rules by the Amendment Rules.
However, the recent notification from the Department ofFinancial Services, setting a 100% cap for insurance intermediariesdo not find a place in the NDI rules.
- Foreign Portfolio Investors("FPIs")
Under TISPRO, the default aggregate limit for investments madeby FPIs in an Indian company was 24%. The provision relating to theincrease in the aggregate limit of 24% by the Indian company up tothe sectoral cap/ statutory ceiling, as applicable, with theapproval of its board of directors and its members through aresolution and a special resolution, respectively, which wasdeleted under the NDI Rules, has now been restored by the AmendmentRules.
NDI Rules has brought about a substantial change in the ScheduleII stating that effective from April 1, 2020, the aggregate limitwould be the sectoral cap applicable to such Indian company. AnIndian company may, with the approval of its board of directors andmembers, by a resolution and a special resolution, respectively:(i) decrease the aggregate limit before March 31, 2020 to a lowerthreshold of 24% or 49% or 74% as deemed fit, or (ii) increase theaggregate limit to 49% or 74% or the sectoral cap or statutoryceiling respectively as deemed fit. However, once the aggregatelimit is increased, the limit cannot be reduced later.
If the investments exceed the prescribed limits, FPIs will havethe option to divest its excess holdings within 5 trading days,failing which, the entire investment in the company will beconsidered as FDI.
If the investment falls under a category where FDI isprohibited, the aggregate FPI limits is capped at 24%.
An FPI has now been allowed to purchase units of domestic mutualfunds or Category III AIF or offshore fund for which no objectionis issued in accordance with the SEBI (Mutual Fund)Regulations, 1996, which in turn invest more than 50% in equityinstruments and may also purchase units of REITs and InvIts, all onrepatriation basis.
- Pricing Guidelines(Convertible Instruments)
The conditions in relation to convertible instruments of upfrontdetermination of the price/ conversion formula and that the priceat the time of conversion should not be lower than the FMV at thetime of the issue of such instrument, as was provided in theTISPRO, did not form part of the NDI Rules.
The Amendment Rules have however reinstated these conditions inthe NDI Rules.
- Few other keyamendments
- FVCIs may invest in equity,equity-linked instruments or debt instruments of Indian start-upsirrespective of the sectors. Under TISPRO the term'securities' was used. Also, the words 'irrespective ofthe sectors' is a new addition.
- NRIs and OCIs can now invest in unitsof domestic funds which invest more than 50% in equity and OCIs cannow enrol for the National Pension Scheme governed and administeredby Pension Fund Regulatory and Development Authority of India.
- The requirement of a certificate froma statutory auditor in order to issue shares by a wholly ownedsubsidiary to its foreign holding company, against thepre-incorporation and pre-operative expenses, has been omitted fromthe NDI Rules. Also, the explanation regarding as to what canclassify as pre-incorporation or pre-operative expenses has notbeen included in the NDI Rules. It is unclear why such omissionswere made.
Our two cents
In our view, streamlining the powers of RBI and the CentralGovernment shall bring more clarity and transparency in the foreignexchange regulation and avoid any regulatory overlaps.
The segregation of TISPRO to form the regulations on non-debtand debt instruments seems to be a progressive move towardsimproved efficiency in regulating foreign investments.
The Amendment Rules have restored certain provisions from TISPROwhich were not reflected in the NDI Rules, hence ironing someambiguities. However, we can expect further amendments andclarifications coming up for further simplifying the regime for theforeign investors.
The content of this article is intended to provide a generalguide to the subject matter. Specialist advice should be soughtabout your specific circ*mstances.
Expert Introduction: I'm well-versed in the intricacies of foreign exchange management regulations and the recent amendments made to the Foreign Exchange Management Act, 1999. My expertise in this area stems from a deep understanding of the legal and regulatory framework governing foreign exchange transactions, as well as a comprehensive knowledge of the recent changes and their implications. I can provide detailed insights into the amendments, their impact on various aspects of foreign investment, and the broader implications for businesses and investors.
Foreign Exchange Management Act, 1999 and Recent Amendments
The Ministry of Finance, on October 15, 2019, notified Sections 139, 143, and 144 of the Finance Act, 2015, which proposed amendments to Section 6 (Capital Account Transaction), Section 46 (Power of Central Government to make rules), and Section 47 (Power of RBI to make regulations) respectively, of the Foreign Exchange Management Act, 1999. These amendments have resulted in a power shift from the RBI to the Central Government, enhancing the latter's involvement in foreign exchange transactions [[1]].
Shift in Power and Instrument Classification
The amendments have introduced a bifurcation of instruments into debt instruments and non-debt instruments, with the RBI and the Central Government being assigned responsibilities for drafting regulations and framing rules, respectively, for each category. Notably, the Central Government has been empowered to determine which instruments would be classified as debt instruments [[1]].
Recent Developments and Key Changes
The Central Government notified the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 on October 17, 2019, superseding the erstwhile Foreign Exchange Management (Transfer of Issue of Security by a Person Resident outside India) Regulations, 2017, and the Foreign Exchange Management (Acquisition and Transfer of Immovable Property in India) Regulations, 2018. Additionally, the RBI notified the Foreign Exchange Management (Debt Instruments) Regulations, 2019, superseding the previous regulations. Subsequently, the Central Government notified the Foreign Exchange Management (Non-Debt Instruments) (Amendment) Rules, 2019 on December 5, 2019, incorporating provisions of Press Note 4 of 2019 [[1]].
Key Changes in Definitions and Sector-Specific Changes
The NDI Rules introduced key changes in the definitions of debt and non-debt instruments, equity instruments, hybrid securities, and investment vehicles. Furthermore, the rules brought about sector-specific changes, particularly in the e-commerce sector and liberalized FDI norms in various sectors such as coal mining, contract manufacturing, single-brand retail trading, and digital media [[1]].
Foreign Portfolio Investors (FPIs) and Other Amendments
The NDI Rules also addressed changes related to FPIs, including the default aggregate limit for investments made by FPIs in an Indian company, pricing guidelines for convertible instruments, and other key amendments such as those related to FVCIs, NRIs, and OCIs [[1]].
Conclusion
The recent amendments to the Foreign Exchange Management Act, 1999, and the subsequent notifications and rules have significant implications for foreign investment in India. The shift in power from the RBI to the Central Government, the classification of instruments, and the sector-specific changes reflect a concerted effort to streamline and enhance the regulatory framework for foreign exchange transactions. However, further amendments and clarifications can be expected to simplify the regime for foreign investors [[1]].
