Overseas Investment Law Revamp: Considerations for Investment in 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 Regime[1]. 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 Entity[2] (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:

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

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.

-     Sahil Shah (Counsel), Shubham Soni (Associate) and Parth Gala (Associate)

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