Introduction
Foreign Direct Investment (FDI) is the backbone of India’s economic vision for transforming into a $5 trillion economy. With an understanding of the crucial role foreign capital plays, the Government of India continues to update and refine its regulatory framework to ease investment inflow as well as to protect national interest. Such a key regulatory framework is the Foreign Exchange Management (Non-debt Instruments) Rules, 2019, or the more popularly known FEMA NDI Rules.
Throughout the years, a few amendments have been introduced to facilitate the process and plug regulatory loopholes. Through this blog, we shall comment on the prominent amendments to the FEMA NDI Rules—namely, the significant alterations instituted via notifications of April 27, 2020 and January 24, 2024—as well as foreign investment in Indian businesses implications thereof. We will also explore the way such amendments attempt to maintain a balance between economic development and national security.
Background: FEMA NDI Rules, 2019
FEMA NDI Rules were brought in to govern foreign investment in equity securities like shares, convertible debentures, partnership interests, etc. They lay down the framework for:
- Channel of entry (automatic/government)
- Sectoral ceilings
- Price guidelines
- Compliance requirements
With the passage of time, as the economic and geopolitical environment of India transformed, these rules have been subjected to significant amendments to respond to arising issues, induce foreign capital, and exercise control over strategic sectors.
Key Amendments of April 27, 2020
Purchase of Securities in a Rights Issue on Renouncement
Rule 7 previously mentioned that foreign investors would be allowed to subscribe to rights issues, and the price should not be worse than for resident Indians. It also had an explanation to provide foreigners with a facility to buy rights shares even if renounced by the initial allottee.
What Changed?
- Explanation under Rule 7 was revoked.
- A fresh Rule 7A was inserted, which reads that price guidelines will now be applicable to rights shares purchased through renouncement by resident Indians.
Implication: This prevents foreign investors from taking shares at freely discounted prices, promoting greater transparency and fairness of pricing.
Single Brand Retail Trading (SBRT) Sourcing Norms Clarified
SBRT permits 100% FDI in the automatic route, subject to some local sourcing norms. Previously, companies with cutting-edge or state-of-the-art technology enjoyed a 3-year exemption from sourcing norms from the opening date of the first store.
What Changed?
- The exemption period now starts from the earlier of opening the first store or commencing online retail.
Implication: The amendment eliminates uncertainty and makes sure that firms initiating e-commerce prior to physical shops are also subject to local sourcing regulations.
100% FDI in Insurance Intermediaries
Press Note 1 of 2020 permitted 100% FDI in insurance intermediaries (agents, brokers, third-party administrators, etc.) under the automatic route.
What Changed?
- This provision was officially included in the FEMA NDI Rules with effect from April 27, 2020.
Implication: Facilitates free flow of capital into the insurance distribution business, improving competition and service delivery.
Divestment and Reclassification by FPIs
Earlier, in case an Foreign Portfolio Investor (FPI) violated investment caps and failed to divest, the entire investment was reclassified into FDI.
What Changed?
- The reclassification now remains subject to additional conditions as may be specified by SEBI or RBI.
Implication: This modification makes regulatory authorities have greater authority in classifying investment, minimizing risks to the system.
Major Amendments Dated January 24, 2024
These changes were brought into effect to facilitate Indian companies tapping international capital markets more efficaciously.
Introduction of “International Exchange”
Definition: Refers to stock exchanges within jurisdictions enumerated in Schedule XI of the FEMA NDI Rules.
Implication: Allows Indian companies to list their equity shares directly on certain foreign exchanges.
Definition of “Listed Indian Company” Expanded
Earlier: Only companies listed on Indian exchanges.
Now: Also includes companies listed on International Exchanges.
Implication: Expands the scope for foreign investment, which can lead to greater capital inflows.
Chapter X: Investment by Permissible Holders
- Permits permissible holders to invest in Indian companies listed/to be listed on an International Exchange.
- Included in the Direct Listing of Equity Shares scheme under Schedule IX.
Implication: Provides Indian companies with greater access to international investors.
Chapter XI: Direct Listing of Equity Shares
- Regulates how Indian public firms issue or offer shares on International Exchanges.
- Shares need to be:
- Dematerialized
- Pari-passu (same rights) with shares listed in India
- Priced no less than domestic issues
Implication: Aligns Indian companies with international listing norms.
Definition of Permissible Holder
Covers beneficial owners of equity shares listed on overseas exchanges.
Special Clause: In case holders are from countries having land borders with India, sanction of Central Government is required.
Implication: Enhances national security without closing the channels of investments.
Compliance Obligations for Listed Indian Companies
These companies have to comply with:
- SEBI acts
- Companies Act
- PMLA
- FEMA rules
- Any laws for issuing equity
Implication: Establishes a strong compliance system to avoid misuse or arbitrage by regulatory authorities.
Press Note 3 (PN3) of 2020: The Amendment Dilemma
In order to stem opportunistic takeovers during such crises as the COVID-19 pandemic, PN3 mandated that entities of nations with land borders with India (particularly China) obtain government sanction prior to investing in Indian entities.
Problems with PN3
Unclear “Beneficial Owner”:
- Lack of clarity results in recourse to various thresholds of other legislation (10% under Indian Companies Act, 25% under FATF).
- RBI has adopted a conservative approach post-2023, resulting in downstream investment controls.
Regulatory Uncertainty:
- Foreign-owned or controlled entities (FOCCs) were served notices for prior investments.
- Legal advisers now advise against recourse to non-FEMA thresholds.
Slow Approval Process:
- Over ₹50,000 crore worth of foreign proposals are delayed or rejected.
- High rejection rate (201 applications in 3 years).
- Heavy penalties: Up to 3x the amount of non-compliant investment.
Proposed Solutions
| Problem | Suggested Solution |
|---|---|
| Vague definition of beneficial owner | Clearly define beneficial ownership (10–25%) with sector-specific thresholds |
| Legal uncertainty | Implement time-framed consultation mechanism with regulators |
| Investor indemnities | Establish provisions in law to shield investors from undue burdens of compliance |
| National security vs ease of investment | Equilibrium by enabling high scrutiny for sensitive areas like defense, telecom, etc., but relaxing norms in others |
Conclusion
India’s FEMA NDI Rules are changing to maintain a fine balance between encouraging foreign investment and ensuring national security. The amendments of 2020 and 2024 capture a twofold agenda:
- Making India more competitive globally by opening the way to wider international listings and greater FDI access
- Enhancing the regulatory surveillance to avoid foreign domination in strategic sectors
Challenges persist, however—particularly with regard to the definition and compliance of beneficial ownership. Resolving these through precise guidelines, sectoral differentiation, and prompt consultations will be essential to ensuring that Indian business—particularly start-ups and SMEs—can prosper with the aid of global capital.
