[Hrithik Merchant is a 4th year law student pursuing BA LLB (Hons.) from National Law School of India University, Bangalore]
The Reserve Bank of India (“RBI”) reported that between April 2000 and August 2022 there was a financial commitment (“FC”) of overseas investment issued to the tune of USD 614 billion. Overseas investment has been accretive with Indian ventures attempting to access global technology, research and development, a wider global market, a reduced cost of capital and boost their brand value. With the numbers snowballing and in a vein of ease of doing business, the Central Government and RBI rolled out the OI Rules 2022, OI Regulations 2022, and OI Directions 2022. Together, the three create a paradigm shift in the OI Framework. The Rules, framed by the government, lay down the overarching framework of investment in all securities abroad except unlisted debt instruments. The Regulations, framed by the RBI, lay down the conditions and manner of investment in unlisted debt instruments abroad as well as the new RBI compliances. The Directions, framed by the RBI, govern the operational requirements for making investment abroad.
The OI Framework has broadly received positive reception with experts touting it to be a fillip in the right direction. A key in the framework is the creation of the distinct categories of Overseas Direct Investment and Overseas Portfolio Investment.
In this post, I attempt to analyse this distinction in three prongs from the perspective of Indian entities: first, the previous regime; second, the modalities of ODI and OPI in the new regime; and third, the commercial ramifications of the ODI-OPI distinction.
The Previous Regime
Previously, the FEMA 2004 Regulations (“2004 Regulations”) read in conjunction with the RBI Directions regulated the Indian ODI space. At the outset, it is imperative to highlight a few features of the old Framework to enable a comprehensive analysis of the new order.
First, the term OPI was never explicitly defined. However, through several amendments over the years starting from 2004, listed Indian companies were permitted to invest up to 50% of their net worth in shares and bonds issued by foreign listed companies.
Second, the 2004 Regulations allowed Indian investments in overseas JV and Wholly Owned Subsidiaries. Furthermore, FC was defined so as to be limited to aforementioned investments. The total FC by an Indian party could not exceed 400% of their net worth, in the old framework.
Third, the 2004 Regulations stipulated the permissible modes for ODI. This included remittances by market purchases, capitalization of exports, guarantees issued to the target entity, investments in agricultural operations, External Commercial Borrowings, and 50% of the value of the performance guarantee.
Fourth, any FC exceeding $1 billion in a financial year would require RBI’s approval notwithstanding whether the total FC is within the permissible limit (400% of the net worth) or not.
It is now necessary to analyse the distinction between ODI and OPI and its modalities under the new regime to answer whether the change is material or simply in the nomenclature.
ODI vs OPI under the New Regime
In a quest to clearly understand the ODI-OPI distinction, we look at the broad framework under which ODI and OPI operate. Firstly, the OI Rules define “Overseas Investment” as FC plus OPI by an Indian resident. FC, in turn, has been defined as amount of investment through ODI, debt (excluding OPI) in a foreign entity/entities in which ODI has been made and non-fund based facilities for ODI.
The OI Regulations stipulate that FC can be made through non-debt instruments as well. This includes debt, guarantee, pledge, and charge. Regulation 3 specifies the eligibility of an Indian entity to extend debt to a foreign entity. The prerequisites are: the Indian entity is eligible to make ODI, the Indian entity has made ODI in the foreign entity, and the Indian entity has acquired control in the foreign entity at the time of making FC. Therefore, debt under FC can be extended only in furtherance of the existing ODI. Now, it behoves us to look at the most crucial definitions – ODI and OPI.
The OI Rules define ODI as investment by acquisition of unlisted equity capital of a foreign entity, or investment in 10% of paid-up capital or control in listed foreign entity. The definition of control is borrowed from the SEBI Takeover Code.
Per contra, OPI is defined as investment in foreign securities other than ODI. OPI essentially includes investment in capital of a foreign listed entity for less than 10% of the entity’s equity capital and without control. Once these thresholds are breached, the investment is ODI. This is in contrast to ODI, where if the investment in the listed foreign entity drops below 10% or there is a loss of control, the investment will still be treated as ODI.
The OI Directions shed greater light on what is excluded in OPI. OPI cannot be made in: unlisted debt instruments, derivatives, and commodities. From this definition, it appears that OPI can be made in listed debt instruments (like debentures) below the 10% and control thresholds. It is hoped that the Centre or RBI issues clarifications positing exactly what debt instruments would be permitted as OPIs. Per contra, ODI does not include debt although debt investment in furtherance of ODI is permitted under the larger umbrella of FC.
While this is the fundamental difference between ODI and OPI, there are several key modalities of ODI and OPI in the OI Framework that animate this distinction.
The total FC made by an Indian entity in all the foreign entities taken together at the time of undertaking such commitment shall not exceed 400% of its net worth as on the date of the last audited balance sheet. Further, FC by an Indian entity exceeding $1 billion in a financial year shall require prior approval of the RBI even when the total FC of the Indian entity is within the eligible limit. Therefore, an Indian entity can make ODI and extend loans up to this 400% threshold. Per contra, the OPI made by an Indian entity shall not exceed 50% its net worth as on the date of its last audited balance sheet.
From a reading of the framework, these limits appear to be mutually exclusive. Therefore, an Indian entity can invest up to 450% (400 in ODI and 50 in OPI) of its net worth in overseas investments. Further, the capsof400% of the net worth for ODI and 50% for OPI and $1 billion overall have remained the same.
Schedules I and II stipulate the manner of making ODI and OPI respectively for Indian entities. An entity can make ODI by the way of subscription as part of memorandum of association or purchase of equity capital, listed or unlisted; acquisition through bidding or tender; acquisition by way of rights or bonus issue; capitalisation; share-swap; or schemes of arrangement.
Per contra, OPI has different provisions for listed and unlisted Indian entities. Listed entities can make OPI in all the forms ODI can be made, including re-investment. However, unlisted entities can make OPI only through rights/bonus issue, capitalisation, share-swap, and schemes of arrangement. This in effect, excludes direct purchase of shares and acquisition through bidding and tender, even though the same may be below the 10% threshold. Therefore, the Rules have been designed in such a manner that unlisted entities cannot remit new capital for OPI and only build upon their existing OPI investments.
While the previous regime prohibited any OPI by unlisted entities, the new entity is not much better since new funds still cannot be remitted.
The modalities of ODI and OPI boil down to the fundamental difference in the purpose of the two. ODI, being direct investment, means that the investor is making long-term commitments of larger amounts with greater interest in the management and functioning of the foreign entity. Naturally, ODI has larger investment limits with investment being done through more channels. Simultaneously, due to higher stakes, it would involve more frequent reporting and monitoring from the RBI. Per contra, OPI, being portfolio investment, means that the investor is investing in stocks to make profits in their portfolios. Consequently, it is subject to tighter limits (both in terms of the equity of the foreign entity and percentage of the investor’s net worth) and through narrower channels. Consequently, OPI results in lesser reporting.
The ODI-OPI definitions have brought no change for listed entities. All forms of ODI and OPI were permissible for the listed companies under the previous regime with the same thresholds. For unlisted entities, one can make a case that now unlisted entities are permitted to make OPI through certain mechanisms. However, as explained earlier, they still cannot remit new funds.
I submit that there is no sound rationale for excluding unlisted entities from making OPI. One might argue that unlisted entities are less regulated with lesser disclosures compared to listed entities resulting in such a restriction. However, any entity making overseas investment has to make appropriate disclosures to the RBI anyway. One might also say OPI market is volatile allowing only listed entities to do the same. However, RBI duly regulates OPIs through its reporting mechanism. Finally, it would be absurd if unlisted entities are allowed to make large ODI investments (up to 400% of their net worth) and not smaller OPIs
The OI Framework brought in a slew of liberal reforms on round-tripping and financial services. With respect to the ODI-OPI distinction, the same has been clarificatory, without being radical. With the Central Government and RBI formulating a new regime, it is crucial for them to create conceptual and definitional clarity in order to streamline the OI laws.
– Hrithik Merchant
“Per contra, OPI has different provisions for listed and unlisted Indian entities. Listed entities can make OPI in all the forms ODI can be made, including re-investment. However, unlisted entities can make OPI only through rights/bonus issue, capitalisation, share-swap, and schemes of arrangement. This in effect, excludes direct purchase of shares and acquisition through bidding and tender, even though the same may be below the 10% threshold. Therefore, the Rules have been designed in such a manner that unlisted entities cannot remit new capital for OPI and only build upon their existing OPI investments.
While the previous regime prohibited any OPI by unlisted entities, the new entity is not much better since new funds still cannot be remitted”
If Unlisted entities were not allowed to make any OPI in earlier regime, and are still not allowed to make any new investments under the new rules.
What is the point of “unlisted entities can make OPI only through rights/bonus issue, capitalisation, share-swap, and schemes of arrangement. ”
Is it because all those things might happen due to a scheme of arrangement such as Merger/Demerger?