The provisions of the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 ("NDI Rules") authorize FPIs to invest in the Indian capital markets and hold equity instruments of listed Indian companies, subject to adherence to the aggregate holding limits-

•  An FPI or an investor group is permitted to hold up to 10% of the total paid-up equity capital of an Indian company on a fully diluted basis.
• The cumulative FPI investment may reach up to the sectoral cap applicable to the Indian company unless the company reduces such cap to 24%, 49%, or 74%, as deemed appropriate, through resolutions passed by the board of directors and shareholders.

In instances where there is a breach of the stipulated holding limits, the RBI has sanctioned that FPIs shall divest within 5 trading days from the date of trade settlement to rectify their positions. Where an FPI elect not to divest within the specified timeframe, the entire holding of such an FPI shall be mandatorily reclassified as FDI.

Although the previous regulations outlined the compliance requirements, the operational guidelines remained ambiguous. To address this gap, the SEBI and the RBI, via SEBI Circular No. SEBI/HO/AFD/AFD-POD-3/P/CIR/2024/152 and RBI Circular A.P. (DIR Series) Circular No. 19, both dated November 11, 2024, have established the operational framework for such reclassification, which is summarized as follows:

1. Permissibility of Reclassification

Reclassification of FPI to FDI shall not be permissible in sectors where FDI is expressly prohibited under the extant regulatory framework.

2. Required Approvals and Concurrences
• Government Approvals: The FPI is mandated to obtain all requisite governmental clearances, including those necessitated for investments originating from jurisdictions sharing land borders with India. The acquisition that causes holdings to exceed the prescribed limit must adhere to the conditions for FDI as outlined in Schedule I of the NDI Rules.

So, where FPI decides to reclassify the holding into FDI, in a sector, where such investment is allowed under the Government approval route, then it has seek to prior approval of Central Government before the reclassification takes place.

• Concurrence from the Investee Company: The FPI must secure concurrence from the relevant Indian investee company to ensure compliance with sectoral caps, prohibitions, and the requirement for governmental approvals as applicable under FDI regulations.
3. Declaration of Intent and Transaction Freezing
• The FPI must formally declare its intent to reclassify its existing foreign portfolio holdings to FDI and must furnish its Custodian with all necessary approvals and concurrence documentation. The Custodian, upon receipt of such documentation, shall initiate a freeze on the FPI’s purchase transactions in the equity instruments of the Indian company until the reclassification process is duly completed.
• Mandatory Divestment: Should the FPI fail to obtain the requisite prior approvals or concurrence, it shall be compelled to divest any holdings exceeding the prescribed threshold within the stipulated period.
4. Reporting Requirements

The reclassification of investment must be reported within the timelines prescribed by the Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019:

• Form FC-GPR: To be submitted by the Indian company where the reclassification stems from a fresh issuance of equity instruments to the FPI.
• Form FC-TRS: To be filed by the FPI where reclassification results from the acquisition of equity instruments in the secondary market.

In either case, the reporting needs to be done for the entire FPI holding, which has been reclassified.  

The AD bank involved must report the reclassified investment as a divestment under LEC (FII) reporting protocols.

5. Transfer of Equity Instruments from FPI demat account to FDI demat account

Upon the completion of requisite reporting, the FPI shall submit a request to its Custodian for the transfer of equity instruments from its demat account designated for foreign portfolio investments to its demat account designated for FDI holdings.

The Custodian, after verifying the completion of reporting requirements, shall unfreeze and effectuate the transfer of the equity instruments. The date of the transaction causing the breach shall be deemed the date of reclassification.

Post-reclassification, the entire investment shall be regarded as FDI, irrespective of any subsequent reduction below the 10% threshold.

This operational framework is designed to facilitate the procedural transition of FPI to FDI and ensure conformity with the prevailing legal and regulatory mandates.

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