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Overseas Investment in Financial Services - MMJC
Introduction: The Ministry of Finance had notified Foreign Exchange Management (Overseas Investment) Rules, 2022 on August 22, 2022 in suppression of Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004.
While the significant changes brought by the new framework included dispensing off the requirement of approval for deferred payment of consideration, write off on account of disinvestment, introduction of late filing fees, it also paved way for Indian entities to invest in overseas entities engaged in financial services as per the Rules.
Erstwhile Framework
Regulation 7 of Notification No. FEMA 120/ RB-2004 allowed investment by an Indian party in an entity outside India engaged in financial services subject to following conditions:
| 1. | The Indian party has earned net profit during the preceding three financial years from the financial services activities | |
| 2. | The Indian party is registered with the regulatory authority in India for conducting the financial services activities | |
| 3. | The Indian party has obtained approval from the concerned regulatory authorities both in India and abroad, for venturing into such financial sector activity | |
| 4. | The Indian party has fulfilled the prudential norms relating to capital adequacy as prescribed by the concerned regulatory authority in India. |
Any additional/ further investment in the overseas entity or its step down subsidiary also required to be in lines with the above conditions.
Revised ODI Framework
The Ministry of finance vide Foreign Exchange Management (Overseas Investment) Rules, 2022 had eased on the conditions for overseas investment in entity outside India engaged in financial services. While the earlier framework allowed only entities engaged in financial services to invest in overseas entity engaged in financial services, the Rules under the revised framework further allowed Indian entities not engaged in financial services in India to invest in overseas entity engaged in financial services.
| Sr No. | Business activity of Indian entity* | Business activity of overseas entity | Situation as per FEMA 120/ RB-2004 (prior to 2022) | Situation as per OI Rules (post 2022) |
| 1 | Indian entity engaged in financial services | Overseas entity engaged in financial services | Allowed, subject to conditions prescribed under Regulation 7 of FEMA 120/ RB-2004 | Allowed subject, to conditions in Para 2(1)** of Schedule I of Rules |
| 2 | Indian entity not engaged in financial services | Overseas entity engaged in financial services | Not Allowed | Allowed subject, to conditions in Para 2 (2)*** of Schedule I of Rules |
| 3 | Indian entity not engaged in financial services | Overseas entity not engaged in financial services | Allowed, except investment in overseas entity engaged in real estate or banking business | Allowed, except investment in :• real estate• gambling in any form and• dealing with financial products linked to the Indian rupee without specific approval of RBI |
| 4 | Indian entity engaged in financial services | Overseas entity not engaged in financial services | Subject to prior RBI permission | Subject to prior RBI permission |
*Indian entity shall mean a company defined under the Companies Act, 2013 or a body corporate incorporated by any law for the time being in force or a Limited Liability Partnership formed under the Limited Liability Partnership Act, 2008 or a partnership firm registered under the Indian Partnership Act, 1932.
| ♦ | **Conditions for ODI in overseas entity engaged in financial services by Indian entity (excluding trust or society) engaged in financial services: | |
| Para 2(1) of Schedule I of the Rules prescribes following conditions for Overseas Direct Investment in overseas entity engaged in financial services by an Indian entity engaged in financial services: |
| 1. | Indian entity has posted net profits during preceding 3 financial years. | |
| 2. | Indian entity is either registered with or regulated by financial services regulator in India | |
| 3. | Indian entity has obtained requisite approvals required in India and the host country/ jurisdiction for carrying out financial services. |
| ♦ | ***Conditions for ODI in overseas entity engaged in financial services by Indian entity (excluding trust or society) not engaged in financial services: | |
| An Indian entity which is not engaged in financial services shall be allowed to make Overseas Direct Investment in overseas entity engaged in financial services (except banking or insurance) subject to condition that such Indian entity has posted net profits during the preceding three financial years. | ||
| ODI in entity engaged in general and health insurance sector shall be permitted for Indian entity provided that such insurance business supports the core activity undertaken overseas. |
ODI in entity carrying out financial services by a Registered Trust or Society
Schedule IV of the Overseas Investment Rules allows registered trust or society engaged in educational sector or which has set up hospitals in India to make ODI subject to conditions with prior approval of Reserve Bank of India.
The conditions prescribed are as follows:
| i. | Foreign entity shall be engaged in the same sector | |
| ii. | The trust or the society shall be in existence for atleast three financial years before making ODI | |
| iii. | Trust deed/ memorandum of association/ rules/ bye laws shall permit proposed ODI | |
| iv. | Such investment shall be approved by the trustees in case of trust or governing body/ council/ managing or executive committee in case of society | |
| v. | In case the trust or the society require special licence or permission either from the Ministry of Home Affairs, Central Government or from the relevant local authority, such special licence or permission has been obtained and submitted to the designated AD bank. |
Thus, it can be identified that a registered trust or society shall be allowed to invest in foreign entity engaged in the same business activity i.e. either education sector or setting up hospitals with prior approval from RBI and shall not be allowed to invest in financial services overseas.
Overseas Investment in IFSC
An Indian entity not engaged in financial services, shall be allowed to make Overseas Direct Investment in IFSC irrespective of it earning net profits in the preceding year or not.
Resident Individuals are also allowed to make Overseas Direct Investment in IFSC irrespective whether the entity is engaged in financial services or not (except in banking and insurance). Provided, where an individual has control in the overseas entity, such entity shall not have subsidiary or step down subsidiary
Conclusion:
| 1. | The OI Rules provide for general permission for |
| • | Indian entity engaged in financial services making ODI in overseas entity engaged in financial services. | |
| • | Indian entity not engaged in financial services making ODI in overseas entity engaged in financial services subject to posting net profits in the preceding three financial years. |
| 2. | However, the Rules do not provide general permission for Indian entity engaged in financial services to make ODI in overseas entity which is not engaged in financial services. Thus, an Indian entity which is engaged in financial services investing in overseas entity not engaged in financial services should seek approval through the AD Bank. | |
| Similarly, Indian entity engaged in financial services for making ODI into an overseas entity which is not registered/ regulated by an overseas financial service regulator (such financial services activity if carried out in India requires to be registered or regulated by financial services regulator) shall seek permission prior to making such investment. | ||
| 3. | The new ODI framework introduced in 2022, has allowed Indian entities not engaged in financial services for making ODI in overseas entity engaged in financial services subject to Indian entity posting net profits as per Rules. This shall enable the Indian entities reap the benefits of return on investment in financial service sectors and engage in financial services overseas. | |
| 4. | Individuals though do not have general permission for ODI in financial services activity overseas (except through esop/ sweat equity/ qualification shares), ODI in entity carrying out financial services in IFSC is allowed. This provides resident individuals an opportunity to invest in financial service sector and enables boost in flow of investments in IFSC | |
| 5. | Statistics pre and post revised ODI framework: |
| July 2022 (Prior to OI Rules) | June 2024 (Post introduction of OI Rules) | |
| Amount in USD millions | Amount in USD millions 1 | |
| Total Overseas Investment | 1109.86 | 2145.57 |
| Investment in financial, insurance and business services | 252.3968 | 544.4024 |
| Percentage of Investment in financial, insurance and business services | 22.74% | 25.37 |