The Foreign Exchange Management (Non-Debt Instruments) Rules, 2019, notified by the Central Government under the FEMA Act, regulate foreign investment in India in equity and equity-linked instruments. While ECBs fall under the debt category and are governed separately, understanding NDI Rules is critical where ECB transactions involve equity-related security creation (e.g. pledge of shares) or where downstream investment or share swaps are involved.
Key Aspects of the NDI Rules
1. Eligible Investors
- Only a person resident outside India is permitted to invest in equity instruments under NDI Rules.
- Entities include:
- Non-resident individuals,
- Foreign entities,
- Overseas Citizens of India (OCIs), and
- Foreign Portfolio Investors (FPIs), depending on the instrument.
2. Permitted Investment Instruments
Foreign investment is allowed through:
- Equity shares,
- Fully, compulsorily and mandatorily convertible preference shares (CCPS),
- Fully, compulsorily and mandatorily convertible debentures (CCD),
- Share warrants (subject to conditions).
3. Entry Routes
Investments can be made through two routes:
- Automatic Route – No prior approval required from the Government of India.
- Approval Route – Prior government approval is required before making an investment, depending on the sector or activity.
4. Sectoral Caps
- Each sector has prescribed investment caps (e.g., 100% in manufacturing, 74% in brownfield pharma).
- Aggregate limits apply to both direct and indirect (downstream) foreign investment.
5. Pricing Guidelines
- Investments and transfers must comply with fair market valuation norms.
- Pricing must be determined:
- As per internationally accepted pricing methodologies,
- Or by a SEBI-registered merchant banker or chartered accountant (as applicable),
- In accordance with sectoral regulations.
6. Downstream Investment
- Investments made by foreign-owned or controlled companies (FOCCs) into other Indian entities are considered indirect foreign investment.
- Such investments must comply with the NDI Rules, including sectoral caps and entry routes.
7. Transfer of Equity Instruments
- Permitted between:
- Residents and non-residents,
- Non-residents inter se,
- On recognized stock exchanges (where applicable).
- Transfer pricing and reporting requirements must be met.
8. Cross-Border Share Swaps
- Indian companies can issue or transfer equity instruments in exchange for equity instruments of foreign companies.
- This mechanism is often used in M&A deals involving foreign entities.
- Recent amendments have simplified procedural requirements and approvals.
Recent Amendments & Clarifications
- Simplification of Cross-Border Share Swaps: Relaxed approval requirements and streamlined processes for strategic mergers/acquisitions.
- Downstream Investments by OCI-Owned Entities: Clearer rules now define how investments by entities owned or controlled by OCIs are treated.
- Unified Definition of “Control”: The concept of control has been aligned with SEBI and Companies Act definitions.
- Alignment of “Startup” Definition: Now consistent with DPIIT’s startup recognition framework for availing investment relaxations.
Relevance to ECB Framework
Although ECBs are governed under the FEMA (Borrowing and Lending) Regulations, interactions with equity (e.g. share pledges, downstream equity investments by ECB-borrowing entities, or M&A restructuring involving ECB liability) require NDI Rule compliance. Therefore:
- Pledge of shares to secure ECB must not violate sectoral caps or FDI norms.
- Invocation of such pledges must follow pricing and transfer rules under NDI.
- Cross-border share swaps involving ECB-holding entities must comply with FDI provisions.
Regulatory Authorities
- RBI: For ECBs and certain investment-related approvals.
- DPIIT: For policy-related FDI approvals.
- AD Category-I Banks: Act as intermediaries for transaction-level monitoring and compliance.
- SEBI: For FPI-related matters and listed company regulations.
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