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FEMA Overhaul and Bifurcation of Debt and Non- Debt Instruments

The Finance Act of 2015 had proposed certain amendments to the Foreign Exchange Management Act, 1999 (“FEMA”). After a long delay, the amendments have finally been notified by the Central Government on October 15, 2019. Pursuant to the notification, the Central Government issued the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“NDI Rules”) and Foreign Exchange Management (Non-debt Instruments) (Amendment) Rules, 2019 (“Amendment Rules”) (collectively referred to as “Rules”) and the RBI issued the Foreign Exchange Management (Debt Instrument) Regulations, 2019 (“Debt Regulations”) and the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019.

The Rules and the Debt Regulations supersede the Foreign Exchange Management (Transfer of Issue of Security by a Person Resident outside India) Regulations, 2017 (“TISPRO”) and the Foreign Exchange Management (Acquisition and Transfer of Immovable Property in India) Regulations, 2018. Under the amended regime, a new classification of debt instruments and non-debt instruments have been introduced wherein the RBI is empowered to frame regulations with respect to debt instruments and the Central Government is empowered to frame rules with respect to non-debt instruments.

Key features of the Rules and the Debt Regulations are as follows:

  1. Equity instruments: The term “capital instruments” used in TISPRO stands replaced by the term “equity instruments” in the Rules.
  2. Debt and Non-Debt Instruments: The Rules provides for an exhaustive list for instruments which are considered as non-debt instruments and includes (i) all investments in equity instruments in incorporated entities: public, private, listed and unlisted; (ii) capital participation in LLP; (iii) all instruments of investment recognised in the foreign direct investment (“FDI”) policy; (iv) investment in units of Alternative Investment Funds (AIFs), Real Estate Investment Trust (REITs) and Infrastructure Investment Trusts (InvIts); (v) investment in units of mutual funds or Exchange-Traded Fund (ETFs) which invest more than fifty per cent in equity; (vi) junior-most layer (i.e. equity tranche) of securitisation structure; (vii) acquisition, sale or dealing directly in immovable property; (viii) contribution to trusts; and (ix) depository receipts issued against equity instruments.

As per the Rules, debt instruments shall include all instruments other than non-debt instruments. The Debt Regulations also separately give examples of certain debt instruments (such as dated government securities/ treasury bills; non-convertible debentures/ bonds issued by an Indian company; commercial papers issued by an Indian company etc.) which can be acquired by foreign portfolio investors, non-resident Indians, foreign central banks etc.

  1. Hybrid Instruments: A definition of “hybrid instruments” has been introduced in the Rules which includes instruments such as optionally or partially convertible preference shares or debentures and other such instruments as specified by the Central Government from time to time, which can be issued by an Indian company or trust to a person resident outside India. However, the above term has not been used in the Rules and the reason for inclusion of this definition is not clear.
  2. Consultation with Central Government: As provided under the TISPRO, the Rules also provide that no person resident outside India shall make any investments in India save as otherwise provided in the FEMA or rules or regulations made thereunder. For cases falling outside the FEMA’s general permission regime, the applicant can approach the RBI for approval. Interestingly, the RBI will now have to consult with the Central Government with regard to applications/cases for (a) permitting a person resident outside India to make any investment in India; (b) permitting an Indian entity or an investment vehicle, or a venture capital fund or a firm or an association of persons or a proprietary concern to receive any investment in India from a person resident outside India or to record such investment; (c) framing of pricing guidelines, documentation and reporting requirements in case of transfer of equity instruments of an Indian company by or to a person resident outside India. This provision for consultation by RBI with the Central Government is a new requirement and could possibly have an impact on the autonomy of exercise of powers by the RBI.
  1. Foreign Portfolio Investors (“FPIs”):

(i)            With effect from April 1, 2020, the aggregate limit for investments to be made by FPIs in an Indian company shall be the sectoral cap/statutory ceiling applicable for the Indian company.

(ii)           An Indian company by means of a resolution of the Board of Directors and a special resolution of the members may (i) on or before March 31, 2020, decrease such aggregate limit for investments by FPIs to a lower threshold to 24% or 49% or 74%; or (ii) increase its aggregate limit, if such company had decreased the same, to the aggregate limit of 49% or 74% or the sectoral cap/statutory ceiling.

(iii)          Once the aggregate limit of FPI investment is increased the same cannot be reduced to a lower threshold by the company.

(iv)          FPIs investing in breach of the prescribed limits will have the option to divest their excess holdings within a period of 5 trading days from the date of settlement of the trade causing the breach. Failure to divest within the aforesaid period will lead to the entire investment being categorised as FDI and the FPI would need to bring the same to the notice of the depositories as well as the concerned investee company for effecting the necessary changes in their records.

(v)           The aggregate limit of FPI investment in an Indian company in a sector where FDI is prohibited shall be 24%.

(vi)          FPIs can now invest in units of mutual funds and Category III AIFs or offshore fund for which no objection is issued under the SEBI (Mutual Fund) Regulations, 1996 and which in turn invests more than 50% in equity instruments on repatriation basis. FPIs may also invest in REITs and InvIts on repatriation basis.

  1. Other Changes

(i)            E-Commerce: The Rules provide that e-commerce activities can be conducted only by companies incorporated under the Companies Act, 1956 or the Companies Act, 2013. Under the earlier regime, foreign companies under Section 2(42) of the Companies Act, 2013 or an office, branch or agency in India as provided in Section 2 (v) (iii) of FEMA, 1999, owned or controlled by a person resident outside India and conducting e-commerce business were also included. Furthermore, every e-commerce marketplace entity with FDI is required to obtain and maintain a report of a statutory auditor by September 30 every year confirming compliance with e-commerce regulations in the preceding financial year.

(ii)           Foreign Venture Capital Investor (“FVCI”): FVCIs can invest in equity or equity linked instrument or debt instrument issued by start-ups irrespective of the sector in which the start-up is engaged. Under TISPRO, FVCIs could invest in “securities” issued by start-ups but it wasn’t clear if the term “securities” was limited to capital instruments or not.

(iii)          Investment by NRIs and OCIs: NRIs and OCIs can now purchase or sell units, without any limit, of mutual funds which invest more than 50% in equity. NRIs and OCIs can also subscribe to the National Pension System administered by the Pension Fund Regulatory and Development Authority, subject to eligibility.

(iv)          Pre-incorporation/pre-operative expenses: The explanation under TISPRO as to amounts which will constitute pre-incorporation/pre-operative expenses and against which capital instruments could be issued by a wholly owned subsidiary to its holding non-resident entity has been omitted under the Rules.


The bifurcation of power and roles concerning foreign exchange transactions between the Central Government and the RBI is intended to bring efficiency and avoid any conflict with respect to foreign exchange transactions. However, it appears that going forward the Government could possibly exercise greater control over the foreign exchange transactions, and it can lead to dilution of authority of the RBI on such issues with possibly a longer approval process for the applicants. As the above regulations are yet to be incorporated in the RBI’s master directions and the FDI policy, the Rules and Debt Regulations are yet to be put in active implementation. We will continue to bring more updates on the Rules and the interpretation/implementation issues in our future write-ups.