Client Updates

August 2022

Liberalization of the Overseas Direct Investment Regime

Introduction • Foreign Entity: The extant concepts of a ‘joint venture’ and

The Reserve Bank of India (“RBI”) had issued Draft Foreign ‘wholly owned subsidiary’ have now been subsumed under a
Exchange Management (Overseas Investment) Regulations, 2021 single definition of a ‘foreign entity’ which refers to an entity
inviting stakeholder comments in August 2021. The RBI has now in formed or registered or incorporated outside India including
consultation with the Central Government revamped the regulatory an International Financial Services Centre (“IFSC”) in India that
regime governing overseas direct investment from India and has has limited liability. It is pertinent to note that IFSCs have been
introduced an entirely new regulatory framework. recognised in the overseas direct investment framework for
the first time as a ‘foreign entity’.
The offshore direct investment framework has been overhauled with
a similar approach that was followed for foreign direct investment • Indian Entity: The concept of an ‘Indian Party’ as defined under
into India, which split the regulatory regime for foreign investment in the Erstwhile ODI Regime has now been substituted with the
debt and non-debt instruments. The Central Government has issued concept of an ‘Indian entity’. The key difference being that
the Foreign Exchange Management (Overseas Investment) Rules, 2022 earlier all investors from India in a foreign entity were together
pursuant to Section 46 of the Foreign Exchange Management Act, considered as an ‘Indian Party’, but now each investor entity
1999 (“FEMA”) which primarily govern overseas non-debt investment will be separately considered as an Indian entity.
framework and the RBI has issued the Foreign Exchange Management
(Overseas Investment) Directions, 2022 and the Foreign Exchange • Subsidiary/Step Down Subsidiary (“SDS”): An SDS of a foreign
Management (Overseas Investment) Regulations, 2022 pursuant entity means an entity in which the foreign entity has ‘control’
to Section 47 (2) of FEMA, which primarily govern overseas debt and the structure of such subsidiary/SDS complies with the
investment framework (collectively the “Revised ODI Framework”). structural requirements of a foreign entity, i.e., such subsidiary/
SDS is also a limited liability entity and the foreign entity’s core
The Revised ODI Framework supersedes the erstwhile overseas activity is not in a strategic sector. Conversely, any investee
direct investment regime governed under the Foreign Exchange entities of a foreign entity where such foreign entity does not
Management (Transfer or Issue of any Foreign Security) have ‘control’ are not to be treated as SDSs and therefore need
Regulations, 2004 (“Erstwhile ODI Regime”) and the Foreign not be reported either.
Exchange Management (Acquisition and Transfer of Immovable
Property Outside India), Regulations 2015. • Control: The Revised ODI Framework has now clarified the
qualitative and quantitative test of the term ‘control’. ‘Control’
The Revised ODI Framework recognizes that Indian companies and refers to the right to appoint majority of the directors or to
businesses have considerably expanded in offshore jurisdictions control the management or policy decisions exercisable by a
in terms of scale of operations as well as revenues and asset base. person or persons acting individually or in concert, directly
The new regulatory framework will enable Indian companies to or indirectly, including by virtue of their shareholding or
leverage their onshore and offshore balance sheets as well as management rights or shareholders’ agreements or voting
their onshore and offshore assets to access both domestic and agreements that entitle them to ten percent or more of voting
offshore forms of financing. rights or in any other manner in the entity. ODI in foreign
entities and SDS is permitted below the ten percent threshold
Regulatory Update also, but such investments will not be eligible for certain
A brief snapshot of the key changes brought about by the Revised specified forms of financial commitments from their Indian
ODI Framework is set out below: entities.
Client Updates

• ODI and Overseas Portfolio Investment (“OPI”): The term extant regime significantly with the key change being an
“ODI” has been defined to mean investment: (i) by way of automatic permission to issue guarantees on behalf of any
acquisition of any unlisted equity capital or subscription foreign entity or SDS, regardless of their level, provided such
as a part of the memorandum of association of a foreign entity is controlled by the Indian entity. Separately, akin to the
entity; (ii) an investment in ten percent or more of the paid requirements under the Erstwhile ODI Regime, prior approval
up equity capital of a listed foreign entity; or (iii) investment of the RBI would still be required to be obtained in cases
with control where investment is less than ten percent of the where the financial commitment by an Indian entity, exceeds
paid up equity capital of a listed foreign entity. OPI on the USD 1 (one) billion (or its equivalent) in a financial year even
other hand primarily means overseas investments other than when the total financial commitment of the Indian Entity is
ODI in foreign securities (except in unlisted debt securities or within the eligible limit under the automatic route (i.e. 400% of
securities issued by Indian residents (except IFCSs)). net worth of the Indian entity in all the foreign entities at the
time of undertaking such commitment).
Interestingly, once classified as an ODI or OPI, the investment
continues to be treated as an ODI or OPI even if does not • Financial commitment by way of investment by way of
fulfil the ‘ten percent’ or ‘control’ or listing threshold at any debt and guarantees: An Indian entity may lend or invest in
subsequent point in time. any debt instruments issued by a foreign entity subject to
the requirement that such loans are duly backed by a loan
• Overseas investment: Overseas Investment means any agreement with the rate of interest being charged on an arm’s
investment by a person resident in India in a foreign entity, length basis. The kinds of guarantees that may be issued
either directly, through SDS or through a special-purpose and the conditions are largely the same as the Erstwhile
vehicle. The foreign entity must be engaged in a bona fide ODI Regime. A new element to note is that if the guarantee
business activity and the subsidiary or SDS of the foreign is extended by a group company, it will be counted towards
entity must also comply with the structural requirements of the utilisation of that group company’s financial commitment
a foreign entity, i.e., it must have limited liability. “Bona fide limit independently, but where the guarantee is extended by
Business Activities” have also been defined clearly to mean a resident Indian promoter, it will be counted towards the
any business activity permissible under Indian laws and financial commitment limit of the Indian entity.
those of the host country. The Revised ODI Framework also
prescribes the manner and detailed conditions for making ODI • Financial commitment by way of pledge
depending on the category of the persons making investments The Revised ODI Framework has significantly relaxed the
including overseas investment by an Indian entities and conditions for leveraging offshore securities and offshore as
resident individuals, overseas investment by registered trusts, well as onshore assets of Indian entities, by permitting the
societies, mutual funds or AIFs, and investment in an IFSC by a creation of security in favour of an overseas lender regardless
person resident in India. of whether such overseas lender is regulated as a bank or not,
and also in favour of a domestic debenture trustees registered
• Financial commitment: The term ‘financial commitment’ with SEBI. Oddly though, while a charge can be created in
has now been redefined to mean the aggregate amount of favour of an overseas lender on onshore assets for facilities
investment by way of ODI, debt other than OPI (i.e. unlisted availed by the Indian entity and its offshore group companies,
debt) and non-fund-based facilities extended by an Indian but no automatic permission has been granted for creation of
entity to all foreign entities. It has been clarified that Indian charge on offshore assets of such a group in favour of overseas
entities may lend or invest in any debt instruments issued by lenders.
a foreign entity or extend non-fund based commitment to or
on behalf of a foreign entity, including overseas SDSs of such The Revised ODI Framework specifies that overseas lenders
Indian entity, subject to the following conditions: should not be from any country / jurisdiction in which
− the Indian entity is eligible to make ODI; ‘financial commitment’ is not permissible under the Revised
− the Indian entity has made ODI in the foreign entity; ODI Framework.
− the Indian entity has acquired control in the foreign entity
on or before the date of making such financial commitment. Set out below is a matrix setting out the permitted security that
may be created by an Indian Entity in relation to any facility availed
The Revised ODI Framework simplifies and liberalizes the under the Revised ODI Framework:
Client Updates

Security by Indian entity In whose favour Facility availed

A) Pledge over equity capital of the AD bank or a public financial institution in Fund/non-fund based facilities for Indian
foreign entity /its SDS outside India. India or an overseas lender. Entity.

Fund/non-fund based facilities for any

foreign entity/its SDSs outside India.

A debenture trustee registered with SEBI in Fund based facilities for Indian Entity.
India.
B) Create charge on its assets (other AD bank or a public financial institution in Fund/non-fund based facility for any foreign
than A above) in India (including the India or an overseas lender. entity/its SDS outside India
assets of its group company or associate Overseas or Indian lender. Fund/non-fund based facilities for Indian
company, promoter and / or director). Entity.
C) Create charge on the assets outside An AD bank in India or a public financial Fund/non-fund based facility for any foreign
India of the foreign entity/ its SDS institution in India. entity/its SDS outside India.
outside India. Fund/non-fund based facility for Indian
Entity.
A debenture trustee registered with SEBI in Fund/non-fund based facility for Indian
India. Entity.

• NOCs from Investigative Agencies and Lender Banks multi layered structures is intended to cover only investments
Another significant aspect to note is the requirement of a No- which result in round tripping into India or even those multi
Objection Certificate (“NOC”) in case the person resident in layered structures which are entirely outside India.
India who is seeking to invest outside India has an NPA or is
classified as a wilful defaulter by any bank or is undergoing • Deferred payment consideration: Significant relaxations have
investigation by any investigation agency namely the Central been introduced to permit payment of consideration on a
Bureau of Investigation, Directorate of Enforcement and the deferred basis for any sale of any equity capital between a
Serious Frauds Investigation Office or a financial service resident and a non resident, subject to compliance with the
regulator. It remains to be seen if entities facing investigation relevant pricing guidelines and the foreign securities having
from Competition Commission of India would be covered been transferred or issued upfront by seller to the buyer. The
under this provision. sellers have been also been permitted to offer indemnity to
buyers in such arrangements.
In a welcome departure from the Erstwhile ODI Regime, the
Revised ODI Framework places the onus on the investigating • Investment in financial services sectors: In a departure from
agency or lender bank to respond to such written applications the Erstwhile ODI Regime, the Revised ODI Framework has now
for an NOC within sixty days. Any failure to furnish such permitted Indian entities not engaged in a financial services
certificate within the stipulated timeline would be construed sector in India to explore opportunities overseas by way an
as a deemed consent to the proposed transaction. ODI in a foreign entity which is directly or indirectly engaged in
financial services activity (other than banking and insurance)
• Round Tripping: The Revised ODI Framework attempts to clarify subject to specified conditions. Similarly, an Indian entity not
some of the regulatory uncertainty surrounding round tripping engaged in the insurance sector has now been permitted to
of investments by Indian entities. However, it still leaves more undertake an ODI in general and health insurance subject to
questions to be answered. Save for certain specified sectors, compliance with stipulated conditions.
any financial commitment by a person resident in India in a
foreign entity that has directly or indirectly invested or invests • Investment in strategic sectors: The term “strategic sector” as
into India at the time of making such financial commitment per the Revised ODI Framework includes energy and natural
(or at any time thereafter), resulting in a structure with more resources sectors such as oil, gas, coal, mineral ores, submarine
than two layers of subsidiaries is not permitted. It is not cable system and start-ups and any other sector or sub-sector
entirely clear if any ODI which results in round tripping but as deemed fit by the Central Government. Note that where
does not breach the two-layer condition would be permitted. the foreign entity’s core activity lies in any strategic sector,
RBI has also indicated that ‘no further layer of subsidiary or the restriction of limited liability structure of foreign entity
subsidiaries shall be added to any structure existing with two shall not be mandatory. Accordingly, ODI in unincorporated
or more layers of subsidiaries post notification of the OI Rules/ companies operating in such strategic sectors has been
Regulations’. Again, it is not very clear if this prohibition on permitted.
Client Updates

Implications their onshore and offshore assets, and will also be able to access
The Revised ODI Framework is the most extensive and a much larger pool of overseas lenders, other than just banks. In
comprehensive review of the Erstwhile ODI Regime as it considers a very positive development, Indian companies can also leverage
the new economic and commercial landscape for corporate India. their offshore assets for onshore financing including for rupee
With an expanding Indian footprint in the overseas markets, the non-convertible debenture issuances without the need for any
revised regime will enhance the ease of doing business outside regulatory approvals.
India significantly.
While we continue to analyse certain areas such validity of multi
The Revised ODI Framework simplifies the overseas investment layered structures outside India and exact contours of prohibition
regime by collapsing different regulatory requirements for credit
of round tripping, any further regulatory clarity on these issues
enhancement at different layers of investments. Indian companies
will be helpful.
will now be able to access global forms of financing by leveraging

Please feel free to address any further questions or request for advice to:

Shardul S. Shroff Pallavi Shroff Akshay Chudasama

Executive Chairman Managing Partner Managing Partner
[email protected] [email protected] [email protected]

Disclaimer
This note is only circulated for discussion purposes and should not be construed as Shardul Amarchand Mangaldas & Co. opining or advising on any matters dis-
cussed herein. Reader should obtain a specific legal advice in relation to any queries on matters discussed herein.

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