Last year, the Reserve Bank of India (RBI) overhauled India's foreign investment regime by issuing the Foreign Exchange Management (Transfer and Issue of Security by a Person Resident Outside India) Regulations 2017 (FEMA 20). Our analysis of the key changes introduced by FEMA 20 is available here.

The RBI has now issued operational instructions to AD Banks by issuing a fresh set of Master Directions on Foreign Investment in India (MD - FI) and amending the Master Directions on Reporting under Foreign Exchange Management Act, 1999 (MD - Reporting).

Please see below an overview of the significant changes and clarifications:

Key Changes and Clarification impacting M&A Transactions

  • Venture capital funds: Under FEMA 20, 'investment vehicles' were defined to include all entities registered with the Securities and Exchange Board of India implying that VCFs would be considered as an investment vehicle. RBI has now specifically carved out VCFs from the definition of 'investment vehicle' in the MD - FI. Accordingly, investments by VCFs with foreign investment will be subject to downstream investment requirements.
  • Foreign portfolio investors (FPI): The following provisions in the master directions with respect to FPIs are noteworthy:

    • FPI ceiling: MD-FI clarifies that investments made by FPIs through off-shore funds, global depository receipts and euro-convertible bonds would not be counted to calculate the ceiling on FPI holdings and only investment in capital instruments acquired through primary and secondary market would be included.
    • Short selling by FPIs: Short selling by FPIs is permissible only if a 2% headroom is available for foreign investment and/ or aggregate FPI investment limits. The designated custodian bank has to report all short selling transactions and lending and borrowing of equity shares by FPIs to RBI on a daily basis.
    • Investment by FPIs in NCDs: Consistent with the approach adopted by SEBI, the MD-FI provides that FPIs can invest: (i) in primary issuance of 'to be listed' non-convertible debentures (NCDs) / bonds only if listing is committed within 15 days of such investment; and (ii) in unlisted NCDs or bonds only if such instruments have a minimum residual maturity of 3 years and end use restrictions on investments in real estate business, capital market and purchase of land.
  • Pricing ambiguity regarding listed securities: The ambiguity prevailing under FEMA 20 regarding the price at which off-market transfer of capital instruments from a resident to a non-resident (NR) should take place has been resolved. While FEMA 20 provided that such transfers should take place at the price applicable to preferential allotments, it was silent as to what the relevant date for such a preferential allotment will be. It has now been clarified that the relevant date for this purpose will be the date of transfer of shares from the resident to an NR.
  • AD Bank's responsibility in financial sector investments: MD – FI now provides that in case of transfer of capital instruments of companies engaged in 'financial sector' from a resident to an NR, the 'fit and proper/ due diligence' requirement regarding the NR stipulated by the respective financial sector regulator is to be complied with by the AD Bank.
  • Downstream investment regime:

    • Funds for downstream investment by Indian entity: Foreign owned and controlled Indian entities (FOCCs) are prohibited from using funds borrowed in domestic markets for making downstream investments. MD – FI clarifies that subscriptions by NRs to NCDs of an Indian company will not be considered as funds borrowed in domestic markets. Accordingly, funds raised by an FOCCs by issuing NCDs to FPIs can be used for making downstream investments. Ability of NRs other than FPIs to subscribe to NCDs of an Indian company for making downstream investments continues to be curtailed by the external commercial borrowing regulations of the RBI.
    • Pricing and reporting of downstream investments: In terms of the MD – FI, the pricing and reporting requirements applicable to downstream investments by FOCCs are as below:

      FOCC Resident No reporting
      Resident FOCC Form DI
      FOCC NR X Form FC-TRS
      NR FOCC Form FC-TRS
      FOCC FOCC X No reporting
  • Issue of partly paid shares: Partly paid shares are required to be fully called up within 12 months from its issuance. MD – FI relaxes this requirement if the issue size is greater than INR 5 billion. In such a scenario, listed companies are required to comply with the requirements of SEBI ICDR Regulations and appoint a monitoring agency. The relaxation is also available to unlisted companies, subject to such company appointing a monitoring agency on the same lines as required in case of listed companies. Further, it has been clarified that partly paid shares cannot be issued in lieu of funds payable to a non-resident (NR) by an Indian company.
  • Amendment to tenure of convertible instruments: MD – FI now provides that the tenure of compulsorily convertible debentures and preference shares can be amended in accordance with the Companies Act 2013.
  • Transfer by pledge:

    • Pledge of capital instruments: FEMA 20 permitted promoters of Indian companies with external commercial borrowings (ECBs) to pledge 'shares' of the borrowing company or associate Indian companies for securing the ECBs. MD – FI clarifies that all 'capital instruments' (and not just shares) can be pledged by the promoters, subject to the conditions set out in MD - FI.
    • Additional restrictions for pledge: MD – FI provides that capital instruments pledged by an NR in favour of an Indian bank, overseas bank or an NBFC and by promoters for securing the ECBs should be unencumbered. Additionally, MD – FI requires companies to obtain a no-objection certificate from its existing lenders, if any, for the creation of such pledge.
  • Mandatory divestments by FPIs, NRIs and OCIs: MD – FI provides that FPIs, NRIs and overseas citizens of India that breach their prescribed ceiling are required to mandatorily divest their holding within 5 trading days after settlement. This requirement will be effective only when the corresponding regulations under FEMA 20 come into force.
  • Effect of change in residential status/ inheritance: MD – FI confirms that security held by an NR which has been inherited from a resident or acquired by him when he was a resident will be held by such NR on a non-repatriation basis.

Key Changes and Clarifications to Reporting regime

  • FC-GPR for FVCIs: While FEMA 20 required filing of Forms ARF and FC-GPR only for foreign direct investment, the MD on Reporting extends this requirement to issuance of capital instruments to foreign venture capital investors as well.
  • Notification to depositories: Indian companies with foreign investment must upload their total foreign investment limits and permissible sectoral limits on portals of the Indian depositories. It is not clear whether this requirement applies only to listed companies or to all companies having shares in dematerialised form. Further, headroom available for proximate scrips must be displayed on the website of the depositories and exchanges.
  • IPOs and QIPs: Form FC-GPR filing is not required to be filed for shares allotted under initial public offer and qualified institutional placements.
  • Late filing fee: MD on Reporting sets out the quantum of late payment fees for delay in reporting foreign investment transactions. The key provisions regarding late payment fees have been summarised below:

    Up to 10 million 0.05 percent INR 1 million or 300% whichever is lower
    More than 10 million 0.15 percent INR 10 million or 300% whichever is lower
    1. The applicable percentage of LSF is doubled every twelve months.
    2. The period of contravention will be considered proportionately and calculated as: (approx. rounded off to next higher month ÷ 12) X amount for 1 year
    3. The period of delay would begin from the day after the 30th day (from the date of receipt of funds/ allotment or transfer of shares) and end on the day preceding the day on which the transaction is reported to the AD Bank. While this is aligned with the ARF and FC-GPR timelines, the timeline for FC-TRS is 60 days from the date of transfer. Accordingly, the manner in which the period of delay will be computed for FC-TRS is ambiguous.
  • Buy-back of shares in an amalgamation: In terms of the MD on Reporting, if a buy back is contemplated under a scheme of merger, demerger or amalgamation, then the Indian company is required to report such transaction by filing Form FC-TRS.
  • Reporting of beneficial interest: If capital instruments of an Indian company are transferred or issued such that the remitter of the consideration is different from the person receiving shares, then, while reporting the transaction in Form FC-GPR or Form FC-TRS, inter alia the following documents are to be submitted: (a) KYC of the remitter and beneficiary; and (b) no-objection certificate from the remitter; and (c) a letter from the beneficiary explaining the reasons for remitter being different.


While the Master Directions has provided interpretational aids on a plethora of issues, clarifications with regard to some key aspects such as ability of an unlisted company to issue warrants, FOCCs' investments in non-convertible instruments, etc are still awaited. Further clarifications from the RBI may be forthcoming in the near future.

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