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Regulatory Hurdles in Downstream Investments: The FOCC Conundrum

The author is Ankit Sharma, a fourth year student at Jindal Global Law School, Sonipat, Haryana.


Rule 23 of the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (“NDI Rules”) deals with downstream investments and prescribes a different treatment for an Indian entity which has received foreign investment and is neither controlled nor owned by an Indian resident or is controlled or owned by a person resident outside India (“PROI”). Such a foreign-owned or controlled company (“FOCC”) becomes instrumental in the hands of foreign investors to undertake indirect foreign investments. While the NDI Rules require certain conditions to be met for downstream investments, ambiguities continue to exist with regard to the treatment of FOCCs. This paper seeks to explore the regulatory hurdles in downstream investments in India which ought to be addressed by the relevant authorities exigently.

Regulatory Hurdles

Reporting Requirements

Rule 23(7)(g) of the NDI Rules defines a downstream investment as an investment made by an FOCC into the capital instruments or capital of another Indian entity. Rule 23(5) of the NDI Rules specifies three scenarios wherein an FOCC may be involved. First, is a transfer of equity instruments in an Indian company by an FOCC to a PROI, which requires adherence to the reporting requirements prescribed by the RBI. Second, is a similar transfer by an FOCC to a person resident in India, which requires adherence to the pricing guidelines. Third, is a similar transfer by a FOCC to another FOCC which requires neither the pricing guidelines nor the reporting requirements to be followed. As can be noticed, the NDI Rules provide for transactions only where the FOCC is transferring equity instruments from an Indian entity to another entity. The said Rules are silent on the requirements to be followed if a FOCC is the one purchasing equity instruments of an Indian entity.

The aforesaid ambiguity becomes significant in light of the inconsistent treatment accorded to FOCCs. If Rule 23(5) of the NDI Rules is considered, the reporting requirements apply to FOCCs only when they are transferring equity instruments to a PROI. In foreign investments, reporting requirements are meant to intimate the government about a cross-border transfer of funds and allow them to enforce the other applicable requirements under the foreign investment law. Against this backdrop, the adherence to reporting requirements in a transfer by an FOCC to a PROI signifies that the NDI Rules treat FOCCs as a resident company, for the reporting requirements.

The question now arises whether the reporting requirements would need to be adhered to if an FOCC is acquiring equity instruments from a PROI. The NDI Rules remain silent upon it, which has led to varied decisions being undertaken by the AD Banks. In this regard, AD Banks refer to the commercial banks, state co-operative banks or urban co-operative banks which have received authorisation from the RBI under Section 10 of the Foreign Exchange Management Act, 1999, to deal in foreign exchange. If an FOCC purchases an equity instrument from another FOCC, it has been noticed that some AD Banks have, in practice required a fresh filing of Form DI. As per Regulation 4(11) of the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019, Form DI is to be filed in the instance of a downstream investment by an FOCC into an Indian company. As noted in Rule 23(5) of the NDI Rules, a transfer between two FOCCs has been exempted from any reporting requirements. AD Banks have in some instances then, applied the NDI Rules improperly due to the ambiguities surrounding the treatment of FOCCs.

Pricing Guidelines

The pricing guidelines were drafted with a view to ensure the maximum intake of foreign exchange in the country while limiting its outflow at the same time. Rule 21 of the NDI Rules provides for pricing guidelines to apply in transactions between a PROI and an Indian resident, but not between two PROIs. Rule 23(5) of the NDI Rules mandates pricing guidelines if an FOCC is transferring capital instruments to an Indian resident. Keeping the intention of the pricing guidelines in mind, it can be determined that the said Rule treats an FOCC as a PROI. In contrast, the NDI Rules as explained above, treat a FOCC as an Indian resident from the reporting perspective.

As with the reporting requirements, the NDI Rules are silent upon the applicability of pricing guidelines if capital instruments are being purchased by an FOCC, whether from a PROI, another FOCC or an Indian resident. It has been observed that while in some cases AD Banks have applied the pricing guidelines in a transaction between a PROI and FOCC, they have not in others. The two existing approaches can cause greater uncertainty if an FOCC is purchasing capital instruments from both a PROI and an Indian resident simultaneously. There then exists a need to lay down a definite and comprehensive framework to govern the transactions entered into by an FOCC.

Capital Instruments and other Attendant Conditions

Although Rule 23(7)(g) of the NDI Rules defines downstream investments as investments made by FOCCs into the capital instruments of other Indian entities, the NDI Rules do not define ‘capital instruments’. A definition for ‘equity instruments’ is provided under Rule 2(k) of the NDI Rules which includes, inter alia, equity shares and convertible debentures. An issue then arises concerning the scope of the phrase “capital instruments.” An optionally convertible debenture (“OCD”) is a kind of debt security which can be converted into shares of a company at a predetermined price and upon the expiry of a certain time period, at the option of the debt-holder or the investor. It is uncertain whether an FOCC that invests in the OCDs of an Indian company would constitute a downstream investment. The RBI in an FAQ for the legislation that preceded the NDI Rules, noted that an investment by a FOCC in a non-capital instrument of an Indian company would not constitute downstream investment. No such clarification exists for the NDI Rules which can permit capital and equity instruments to be equated. As such, uncertainty regarding the permissibility of investments into OCDs by an FOCC persists.

Under Rule 23(1) of the NDI Rules, conditions applicable in the case of Foreign Direct Investment (“FDI”) such as “entry route, sectoral caps, pricing guidelines and other attendant conditions” apply for downstream investments as well. Considering the wide ambit of the phrase “other attendant conditions,” it remains uncertain to what extent the regulations that govern foreign investment apply to a downstream investment. If the entirety of the requirements in a FDI is considered to apply, it would be according to FOCCs, a treatment equivalent to that of a non-resident. The same would add to the regulatory burden in downstream investments and eliminate the incentive to enter into such transactions.


Presently, FOCCs are treated as PROIs from the pricing perspective and as Indian residents from the reporting perspective. Such a dual approach is unsustainable in the long run and is bound to increase the regulatory red tape and cause confusion amongst investors. A uniform treatment of FOCCs must then be considered in India to regulate such entities better. It is suggested then that FOCCs be treated as PROIs for all purposes, given that they are controlled or owned by a PROI.

For any purchase or sale of equity instruments in an Indian company between FOCCs on one hand and resident companies or PROIs on the other, both the pricing guidelines and reporting requirements should apply. This is on account that the said transaction may involve not just an inflow or outflow of foreign exchange, but also a change in control of a domestic company in favour of a foreign entity indirectly. In contrast, a transaction between two FOCCs would represent a transaction brokered by the PROIs controlling the same. Such a transaction would neither result in any inflow or outflow of foreign exchange nor a change in control of the domestic company. In such circumstances, as is stipulated by Rule 23(5)(c) of the NDI Rules presently, no pricing guidelines or reporting requirements may be prescribed.

A definition for ‘capital instruments’ must be provided in the NDI Rules and it may be clarified that given the nature of OCDs, a FOCC would be regarded as having undertaken downstream investment when the OCD is converted into equity shares. The scope of “other attendant conditions” under Rule 23(1) of the NDI Rules requires elucidation too and it is urged that the same be construed restrictively, to not render regulations governing downstream investment as burdensome as in FDI.


The NDI Rules treat FOCCs as PROIs from a pricing perspective and Indian residents from a reporting perspective. Such a dual approach results in regulatory hurdles when undertaking downstream investments in India. Instead, a uniform approach to treat an FOCC as a PROI must be adopted. Given the uncertainty around investments made by FOCCs into OCDs of domestic entities, it is suggested the same be construed as downstream investments when the debt instruments are converted into equity capital. It is also pertinent to not drag in all the attendant conditions applicable in a FDI, in the instance of a downstream investment. To streamline the mechanism of downstream investments in India then, it is essential to clear any ambiguities that may arise in implementing the NDI Rules. It is hoped that the legislature brings in suitable amendments at the earliest and clears the conundrum surrounding FOCCs in India.

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