Alternative Investment

Overseas Investment Law Revamp: Considerations For Investment In Financial Services – Financial Services

Introduction

Over the past week, the Government of India (GOI) and Reserve
Bank of India (RBI) have revamped the overseas investment
architecture for persons resident in India with the New OI
Regime1. Khaitan & Co. has on 24 August 2022,
already shared an update on the overall framework of the New OI
Regime (available
here
), outlining the key changes introduced through such
regime. This update addresses the impact on financial services
sector.

The New OI Regime, among other changes, bring in significant
development for persons resident in India looking to make overseas
investment in financial services sector, including in Gujarat
International Finance Tec-City (GIFT) based International Financial
Services Centre (IFSC). This Ergo seeks to cover specific elements
in relation to overseas investment by resident individuals, Indian
Entity2 (engaged in financial services activity
(FSA)3) and Indian Entity (not engaged in FSA) in the
financial services sector under the New OI Regime.

Briefly, the New OI Regime has broadly categorized overseas
investments into financial commitment (which includes overseas
direct investments (ODI)) and overseas portfolio investments (OPI).
The focus of the different routes is as under:

  • ODI Route – The ODI route focuses on
    investment by way of acquisition of unlisted equity
    capital4 of a foreign entity5, or through
    subscription as part of memorandum of association of a foreign
    entity or investment in 10% (ten percent) or more of the paid-up
    equity capital of a listed foreign entity or investment with
    control where investment is less than 10%.

  • Financial Commitment – It is the aggregate
    amount of investment made by a person resident in India through
    ODI, debt other than OPI in a foreign entity(ies) in which ODI is
    made and includes non-fund-based facilities extended by such person
    to or on behalf of such foreign entity(ies).

  • OPI Route – The OPI route is for investment in
    foreign securities other than ODI, with an exclusion of unlisted
    debt instruments or any security issued by a person resident in
    India who is not in an IFSC.

Snapshot of the FSA investment framework under the New
OI Regime
:



























Sr. No.

Particulars

Resident Individual

Indian Entity (engaged in FSA)

Indian Entity (not engaged in FSA)

1

Investment in FSA in Foreign Entity in
GIFT/IFSC

Yes, under the ODI or OPI Route, subject to LRS6
limits. The investment shall be made in the manner provided in
items 6 and 7 below.

Yes, under the ODI or OPI Route. Investment in ODI Route is
subject to the terms and conditions briefly covered in item 5
below. OPI doesn’t appear to be subject to any conditions. The
investment shall be made in the manner provided in items 6 and 7
below.

2

Investment in FSA in Foreign Entity (Outside
GIFT/IFSC)

Yes, under the ODI or OPI Route, subject to LRS limits. The
investment shall be made in the manner provided in item 6
below.

Yes, under the ODI or OPI Route. Investment in ODI Route is
subject to the terms and conditions briefly covered in item 4
below. OPI doesn’t appear to be subject to any conditions. The
investment shall be made in the manner provided in item 6
below.

3

Investment Limits

Subject to the overall ceiling under the LRS i.e., USD
2,50,000/-

  1.  

For ODI: Up to 400% of net worth of Indian Entity

  1.  

For OPI: Up to 50% of net worth of Indian Entity

4

Conditions for ODI in Foreign Entity (Outside
GIFT/IFSC)

No other conditions apart from investment limit identified
above.

  1.  

Indian Entity posting net profit during preceding 3 financial
years.

  1.  

Foreign Entity should not be engaged in banking or insurance
(excluding general and health insurance activities supporting other
core business).

  1.  

Indian Entity being registered or regulated by a financial
services sector regulator in India.

  1.  

Indian Entity posting net profit during preceding 3 financial
years.

  1.  

Indian Entity having obtained approval, as may be required, from
concerned financial services sector regulator in both India and
host jurisdiction.

5

Conditions for ODI in a Foreign Entity in
GIFT/IFSC

No other conditions apart from investment limit identified
above.

  1.  

Indian Entity posting net profit during preceding 3 financial
years.

Foreign Entity should not be engaged in banking or insurance
(excluding general and health insurance activities supporting other
core business).

  1.  

Indian Entity being registered or regulated by a financial
services sector regulator in India.

 

  1.  

Approval of financial services sector regulator concerned in
India (wherever applicable), to be decided within forty-five (45)
days, failing which it shall be deemed approval.

6

Manner of investment in Foreign Entities

ODI or OPI by way of:










  1.  

Inheritance

  1.  

sweat equity shares

  1.  

minimum qualification shares issued for holding a management
post in a Foreign Entity

  1.  

shares or interest under Employee Stock Option Plan (ESOP) or
employee benefit plan.


Resident individuals are permitted to make investment under OPI
Route, including by way of contribution to investment fund and
carry vehicle.


Note: (ii), (iii) and (iv) shall be treated OPI
if the acquisition of equity capital is

ODI is permitted in equity capital for purpose of undertaking
bonafide business activity by way of:














  1.  

subscription as part of memorandum of association or purchase of
equity capital, listed or unlisted;

  1.  

acquisition through bidding or tender procedure;

  1.  

acquisition of equity capital through rights issue or bonus
shares;

  1.  

capitalization of the amount due to the Indian Entity by the
Foreign Entity, where such remittance is permitted and does not
require prior approval;

  1.  

swap of securities; and

  1.  

merger, demerger, amalgamation, or scheme of arrangement.


If listed, Indian Entity is permitted to make investment under
OPI Route, including by way of contribution to investment fund.
However, for unlisted Indian Entities, OPI is only permitted in
(iii) (iv) (v) and (vi) above.

7

Manner of Investment in Foreign Entities based in GIFT/
IFSC

In addition to manner of investment items specified in item 6
above, ODI is further relaxed for investment in entities in
IFSC/GIFT. 


ODI is permitted by resident individuals in all instruments of
Foreign Entity engaged in FSA in IFSC (except banking and
insurance), with no subsidiary or step-down subsidiary outside
IFSC.


Indian individual may also make contribution to investment fund
or vehicle set up in IFSC as OPI.

In addition to manner of investment items specified in item 6
above, ODI is further relaxed for investment in entities in
IFSC/GIFT.


Indian Entities may also make contribution to investment fund or
vehicle set up in IFSC as OPI, which under item 6 above was
restricted for unlisted Indian Entities.

Comment

Financial services activity defined:
The New OI Regime has now defined the scope of FSA. As such, the
term ‘regulated’ may be construed to bring into its ambit
entities such as the investment managers of alternative investment
funds, which may not necessarily hold a registration with the
financial services sector regulator but are considered as deemed to
be regulated by the Securities and Exchange Board of India.

Investment in financial services sector by Indian
Entity not engaged in FSA
: In a welcome deregulation,
Indian Entities not engaged in FSA are now allowed to invest in
financial services sector, subject to net profit requirements. This
is a welcome move allowing the Indian Entities to either foray into
financial services business outside India or merely participate by
way of investment in an investment fund outside India. Previously,
the regime required all entities to be registered with financial
services sector regulator prior to investing in financial services
sector.

IFSC made attractive: The GOI has made
its intent clear to promote IFSC as a crucial overseas investment
destination by (i) allowing Indian Entity not engaged in FSA to
invest in IFSC through ODI route without net profit requirements;
(ii) expanding the scope of OPI in IFSC by allowing Indian Entities
to contribute in investment funds or vehicles; (iii) allowing
resident individuals to make ODI investment in Foreign Entity
(including entities engaged in FSA) subject to certain conditions;
and (iv) introducing deemed approval concept within 45 days for
Indian Entities regulated by a financial service sector
regulator.

Reduced approval requirements: In a
departure from its earlier position, the requirement for approvals
from financial services sector has been made ‘as may be
required’. As such, it seems that (i) no approval is required
for Indian Entity not engaged in FSA for overseas investment in
financial services sector; and (ii) no approval is required unless
laws of Indian party or host country specifically require such
approvals.

Gift of foreign securities in FSA by
residents
: While paragraph 2 under Schedule 3 of ODI
Rules seems to limit the investment avenues available in FSA by
residents, paragraph 3 under Schedule 3 of ODI Rules however
appears to offer full flexibility for gift of foreign securities
including in financial services sector subject to conditions laid
down therein.

Net profit calculation, round tripping and other
supplementary changes
: In addition to the above, the
New OI Regime seems to expand the net profit requirement to any
business conducted by the Indian entity, and not restrict it to net
profit from FSA only. The New OI Regime also seems to permit round
tripping with express restriction on more than two-layer of
subsidiaries only. Clarity has also been provided on what forms a
subsidiary, step down subsidiary, control, etc.

Conclusion

The New OI Regime has taken a significant step towards relaxing
and simplifying the overseas investment regulations for the
financial services sector. At the same time, there seems to be
clear push to make IFSC or GIFT an attractive destination for
overseas investment and structuring and to encourage new entrants
in the financial market. This will also help in preserving the
valuable foreign exchange within the country.

While the New ODI Regime is a welcome move, its seamless
implementation will have to be seen. As is expected, there is
considerable amount of queries on interpretation, including on
two-layer structures, terms such as ‘investment fund or
vehicle’ and whether structures such as ‘venture capital
company’, will be considered a body corporate with limited
liability, or an ‘investment fund’. However, in general,
the change has been welcomed with enthusiasm for now.

Footnotes

1 “New OI Regime” refers to collectively (i)
the Foreign Exchange Management (Overseas Investment) Rules, 2022
(ODI Rules); (ii) Foreign Exchange Management (Overseas Investment)
Regulations, 2022 (ODI Regulations); and (iii) Foreign Exchange
Management (Overseas Investment) Directions, 2022 (ODI
Directions).

2 “Indian Entity” means (i) a company defined
under the Companies Act, 2013 (18 of 2013); (ii) a body corporate
incorporated by any law for the time being in force; (iii) a
Limited Liability Partnership duly formed and incorporated under
the Limited Liability Partnership Act, 2008 (6 of 2009); and (iv) a
partnership firm registered under the Indian Partnership Act, 1932
(9 of 1932).

3 An entity will be considered to be engaged in
‘financial services activity’ or ‘FSA’ if it
undertakes an activity which if carried out by entity in India,
required registration with or is regulated by a financial sector
regulator in India.

4 “Equity Capital” means equity shares or
perpetual capital or instruments that are irredeemable or
contribution to non-debt capital of a foreign entity in the nature
of fully and compulsorily convertible instruments.

5 “Foreign Entity” means an entity formed or
registered or incorporated outside India, including International
Financial Services Centre that has limited liability: Provided that
the restriction of limited liability shall not apply to an entity
with core activity in a strategic sector.

6 LRS means Liberalized Remittance Scheme of
RBI

The content of this document do not necessarily reflect the
views/position of Khaitan & Co but remain solely those of the
author(s). For any further queries or follow up please contact
Khaitan & Co at legalalerts@khaitanco.com

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