Outbound investments from India have been traditionally governed by the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004 (FEMA 120).

Now, the Reserve Bank of India (RBI) has brought in a Draft Foreign Exchange Management (Overseas Investment) Regulations, 2021, and Draft Foreign Exchange Management (Non-debt Instruments – Overseas Investment) Rules, 2021. It has invited public comments on these. The new regime would bring about a sea change. However, there is scope for more refinement before it comes into effect.

Overseas direct investment

This concept from FEMA 120 has been expanded by the 2021 Rules. FEMA 120 broadly covered primary and secondary acquisition of shares in a foreign entity but did not include portfolio investments. Under the 2021 Rules, “overseas direct investment” (ODI) distinguishes between investment in unlisted and listed entities; and includes sponsor contribution to fund vehicles.

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For listed entities, the investment size should be equal to or more than 10 per cent, mirroring the definition of FDI. Investments in energy and agricultural space are specifically addressed. This poses interpretation challenges and are discussed contextually.

Energy sector

Acquisition of “Participating interest/right” in the energy sector constitutes ODI. There are multiple questions that arise from here. In the first instance, “Participating interest/right” is not defined. It would be important for the 2021 Rules to specify that this would imply some form of management control and/or economic interest in a foreign entity (as defined in the 2021 Rules), rather than a commercial/contractual right to use energy assets such as gas pipelines or power distribution cables.

The 2021 Rules also define “strategic sectors” to include energy and natural resources sectors such as oil, gas, coal and mineral ores or any other sector that may be advised by the Central government. However, the definition of ODI singles out only the energy sector, not “strategic sector”; thereby excluding the natural resources sector. Not only is the reason for this unclear, but practical distinction would also be difficult.

For instance, is coal to be counted as energy sector or natural resources sector? Furthermore, it is unclear whether overseas investments in non-energy strategic sectors should only be through routes other than ODI – such as overseas portfolio investment (thus, largely in listed securities and governed by Schedule II of the 2021 Rules) or other forms of financial commitments (which the 2021 Regulations cover as debt, guarantee, pledge or charge).

Under the circumstances, it is to be considered whether the construct of participating interest/rights and energy sector at all need to remain specifically in the definition of ODI.

Agriculture sector

The 2021 Rules state that investment outside India in agricultural operations as provided under the 2021 Rules and 2021 Regulations shall also be treated as ODI by way of equity capital. The rationale for treating investments in this sector as ODI by way of equity capital is unclear – though ODI as a concept under the 2021 Rules is largely centered around acquisition of equity shares, it is not limited to investments only by acquiring equity capital.

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For instance, acquisition of direct/indirect control otherwise than through holding equity shares should have constituted ODI but for this clarificatory language in the definition. Unfortunately, this notion is reinforced in language in the 2021 Regulations as well.

Schedule I of the 2021 Rules makes no such specific distinction, thereby creating ambiguity on whether the ODI regime would govern acquisition of control in agricultural operations other than through holding of equity capital. Could it be that investment in agricultural operations is intended only as ODI by way of equity capital and not under any other route?

It may serve well to add that the reference to investments under the 2021 Regulations counting as ODI by way of equity capital also remains mystifying, as the 2021 Regulations expressly cover other routes that do not constitute ODI, being financial commitment by way of debt, guarantee, pledge or charge. To treat these as ODI by way of equity capital may be difficult and infructuous.

If indeed the legislative intent is to provide a certain treatment to investments in agricultural operations, it may serve better to address it in procedure-related provisions (permissions, limitations etc) rather than in the conceptual clauses such as the definition of ODI. The 2021 Rules and 2021 Regulations are well intentioned but have built within themselves several inconsistencies that at the time of implementation may create challenges. Therefore, a thorough review to iron these out before replacing FEMA 120 should be considered.

(The author is Mumbai-based Corporate Partner with HSA Advocates, and additionally heads the practice for the Firm’s Kolkata Office. Views expressed herein are personal and not to be construed as legal advice.)

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