Contributed by Aayush Ambasht, Param Kailash and Sudiksha Moorthi

Introduction and Background

With the ideation of the Gujarat International Finance Tec-City Project in 2007, the dream signalled a shift in corporate legislative intent, underlying a forefront initiative to create a global financial hub. The gateway for global financial services in the Indian economy witnessed over 80 fund managers setting up shop, committed to over $30 billion and investments exceeding $2.93 billion over the course of the last three years. However, regulatory clarity regarding Overseas Investments was sought by key players in the landscape, and the consequent alignment of such clarity with the goal of creating an International Financial Services Centre (IFSC) was crucial.

On July 7, 2024, the Reserve Bank of India (RBI) by way of a Circular, has amended the Foreign Exchange Management (Overseas Investment) Directions, 2022 (FEM Directions). Through this development, the apex financial regulator seeks to widen the net for foreign investments made by Category-1 Authorized Dealer (AD) Banks, boosting the thrust for IFSCA’s GIFT City corridor. This paper seeks to delve into the intricacies of these changes and elaborate upon the specific infusion of flexibility provided to both resident Indians and overseas funds for foreign investment opportunities. It shall highlight key takeaways from the circular, its effects on the ease of doing business in India, navigate cross-jurisdictional lessons and discern concluding remarks on the matter at hand.

Meaning of Overseas Portfolio Investments

According to the FEM Directions, Overseas Portfolio Investments (OPI) means investment other than Overseas Direct Investments (ODI) in foreign securities. In this regard, the term ODI has been defined to expressly include, inter alia, investment in 10% or more of the paid up equity capital of a listed foreign entity, or investment with control where investment is less than 10% of the paid up equity capital of a listed foreign entity.

It is to be further noted that:

1. OPIs shall not include derivatives (unless prescribed by RBI), unlisted debt instruments, any security which is issued by a person resident in India who is not in an IFSC; or any commodities including bullion depository receipts.

• OPIs made by resident Indians in a listed entity, even after its delisting, shall continue to be treated as OPI until any further investment is made in the entity.

• OPIs may be made by unlisted entities as well as by way of reinvestments provided under Schedule II of the FEM Directions.

• OPIs shall include any investment made overseas in accordance with schedule IV of the OI Rules in securities as stipulated and registered by SEBI in the form of mutual funds, venture capital funds and alternative investment funds.

• OPIs must be made within the overall limit for the liberalised remittance scheme in terms of schedule III of the FEM Directions.

Brief Overview of the Amendment

Pursuant to this amendment coming into force, key changes from the same are as follows: 

1. Investments (including sponsor contributions) in the form of units or any other instrument “by whatever name called” issued by an overseas fund, which is “duly regulated” by the financial regulator in the host jurisdiction. The same shall be made by way of investment funds or vehicles, subject to restrictions imposed thereunder by Schedule V of the FEM Directions. This will be applicable to resident Indians (including individuals and both listed and unlisted entities) and shall constitute treatment as an OPI.  

• Investments (including sponsor contributions) in the form of units or any other instrument “by whatever name called”issued by an overseas fund set up in an IFSC, are permitted to be made by resident Indians (including individuals and both listed and unlisted entities). This shall constitute treatment as OPI.

Rationale behind the Amendment

By virtue of this amendment, the RBI cushions overseas portfolio investments to be modelled across a broader formulation of instruments, not limited to units or any other prescribed form of securities in any particular jurisdiction. Therefore, such a liberalised regime ensures diversified market participation as well as greater flexibility for leveraging foreign exchange routes; underscoring global accessibility to the IFSC’s GIFT City for resident Indians (including individuals and both listed and unlisted entities).

Analysis and Implications

While the erstwhile directions governing the definitive compliance considerations of overseas investments left some unaddressed concerns for AD Banks, the new regime clears the air on nuances pertinent to the same.

Firstly, inducing clarity on what constitutes as “duly regulated” investments (including sponsor contributions) has been made, which shall also include “funds whose activities are regulated by financial sector regulator of host country or jurisdiction through a fund manager.” Based on the sentiment set by this explanation, flexibility from the purview of – jurisdiction, nature of financial instruments/units (inserting – “by whatever name called”) and end user fund structures has been provided to fund managers. Secondly, since the extant directions which curbed overseas investments in “any foreign entity/its subsidiaries engaged in banking or insurance” has been waived off, larger impetus to diversify control within transactional arrangements (regardless of any sectoral restriction) have been granted. Thirdly, this amendment signals an overall alignment with modalities for  portfolio management services charted out in the IFSCA (Fund Management) Regulations, 2022 resulting in uniformity of financial regulation at large.

Be that as it may, navigating unaddressed complexities with this consolidation mechanism deems to be of urgent importance. In light of the same, devising a litmus test for disclosures, security creation as well as tax treatment must be made for transactions involving obligations pertaining to change in control, share swaps and/or acquisitions of foreign entities. Further, outlining a stringent code of conduct for fund managers is critical for ensuring corporate governance, transparency and risk management. Additionally, addressing the investment computation conundrum by way of Exchange Earners’ Foreign Currency Accounts (as maintained by AD Banks) must be made by the regulator from a monetary settlement and book-keeping perspective. Also, prescribing requisite ticket sizes vis-à-vis corpus limits for making such overseas investments shall help harmonize ease of doing business along with valuation floodgates which may be likely to arise in the future.

While accounting for the specific impact that the amendment funnels into foreign investment landscapes, the change proves to be satisfactory and permits harmonious integration onto foreign jurisdictions and their respective regulatory compliances.  In lieu of the need for global alignment, it must be noted that the amendment permits investment onto Variable Capital Company funds set up in states enforcing Clear-Tax Systems such as Delaware, and in other cases, Double Tax Avoidance Agreements (DTAA), as witnessed in the case of India’s DTAA with Singapore. Lessons from such notable global regulatory frameworks, may be structurally incorporated in the Indian scenario, which shall help leverage business interlinkages and overall tax management.

In brief, the shift signifies concurrence with foreign jurisdictions by expanding the scope of the form of investments used, underlying an increased reliance upon fund managers to impose ethical financial conduct and regulatory compliance. The FEM directions highlight its key rationale of remaining aligned with the essence of a liberal regulatory environment and develop ease in execution of business activities, naturally ensuring integration with global jurisdictions, and overseas portfolio expansion opportunities in the GIFT City.  

Concluding Remarks

With the current shift in dynamics for tailoring foreign portfolio investments, RBI’s approach in this regard is undoubtedly forthcoming from the ends of strategic investment allocation at a global scale. However, the sanctity of the aforementioned amendment awaits market response with regards to navigating ambiguities in private equity injection or forecasting its potential upside returns. Given India’s changing regulatory environment alongside overseas investment interest for IFSCA’s GIFT City opportunity, this move furnishes a bright way forward for consolidating international investment discipline with Indian money markets.