India Rewrites Its Foreign Investment Architecture: A Guide to the Draft Foreign Exchange Management (Foreign Investment) Rules, 2026
Summary: The Ministry of Finance (Department of Economic Affairs) has circulated the draft Foreign Exchange Management (Foreign Investment) Rules, 2026, which, if enacted, will replace the Foreign Exchange Management (Non-debt Instruments) Rules, 2019. The draft changes the framework from a non-debt instrument approach to one based on foreign investment in equity, excludes IFSC-incorporated financial institutions, expands the definition of eligible investee entities to include investment vehicles, partnership firms and proprietary concerns, and revises the definition of equity by linking it to applicable accounting standards and specified investment vehicle units. It codifies indirect foreign investment, retains the 10% threshold distinguishing FDI and foreign portfolio investment, clarifies the definition of Foreign Controlled Entity, formally allocates regulatory responsibilities between the RBI and DPIIT, and consolidates permissible modes of acquisition and transfer, including equity swaps and depository receipts. Annexure I introduces a framework for direct overseas listing of Indian companies, covering eligibility, holding, transfer, pricing and compliance requirements. The draft retains existing pricing principles, places compliance obligations on both foreign investors and eligible investee entities or transfer parties, and notes that Annexures II and III, containing the FDI Policy and applicable RBI regulations, are yet to be made available.
Introduction
The Ministry of Finance (Department of Economic Affairs) has circulated a draft of the Foreign Exchange Management (Foreign Investment) Rules, 2026 (“Draft FI Rules” or “Draft Rules”). If enacted in their current form, the Draft Rules will entirely supersede the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“NDI Rules”)—the primary statutory instrument governing inbound foreign equity investment into India for the past six years.
The Draft Rules represent far more than a consolidation exercise. They introduce material changes to the definitional architecture of the foreign investment framework, recalibrate the treatment of indirect investment and downstream structures, expand the universe of eligible investee entities, and embed—for the first time at the Rules level—a scheme for the direct overseas listing of Indian companies. The Draft Rules also formally codify the regulatory allocation between the Reserve Bank of India (‘RBI’) and the Department for Promotion of Industry and Internal Trade (‘DPIIT’), a division that has long operated in practice but without explicit statutory articulation.
Given that every inbound equity investment into India—from a straightforward FDI subscription to a complex M&A acquisition—will fall within this framework, in-house counsel, CFOs and foreign investors should engage with the Draft Rules with care.
Background
The NDI Rules, 2019 were themselves a consolidation of what had previously been a fragmented landscape: the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 and a series of prior notifications. Despite the 2019 consolidation, several structural tensions persisted:
– The definition of ‘non-debt instruments’ in the NDI Rules was framed by exclusion rather than affirmatively, creating interpretive difficulty at the margins—particularly for hybrid instruments and units of investment vehicles.
– The treatment of indirect foreign investment through Foreign Controlled Entities (‘FCEs’) and the concept of ‘deemed foreign investment’ remained a persistent source of uncertainty, especially in the context of multi-layered holding structures and downstream investments.
– The allocation of regulatory authority between the RBI (which administers FEMA) and DPIIT (which issues the FDI Policy) was understood by practitioners but not articulated in the NDI Rules themselves, leading to occasional ambiguity about which regulator’s guidance prevailed on a given point.
– The absence of a statutory framework for direct overseas listing of Indian companies—despite the introduction of the Companies (Listing of Equity Shares in Permissible Jurisdictions) Rules, 2024—meant that the FEMA dimensions of such listings rested on regulatory guidance rather than primary rules.
The Draft Rules address each of these tensions, though the solutions introduced raise questions of their own.
Analysis of Key Changes
1. Renaming and Scope (Rules 1 and 2)
The shift in nomenclature from ‘Non-Debt Instruments’ to ‘Foreign Investment’ is not merely cosmetic. The NDI Rules defined their scope by reference to the category of instrument (non-debt); the Draft Rules instead define scope by reference to the nature of the transaction (foreign investment in equity). This reframing anchors the statute to the economic substance of what it regulates—cross-border equity flows—rather than a definitional residual category.
IFSC-incorporated financial institutions are expressly carved out from the Draft Rules’ application, consistent with the policy objective of treating IFSC as a separate regulatory jurisdiction.
2. Eligible Investee Entity—Expanded Universe (Rule 3(b))
The definition of ‘eligible investee entity’ is meaningfully wider than under the NDI Rules. It now expressly includes:
– Investment vehicles—REITs, InvITs, AIFs, Venture Capital Funds, Mutual Funds and ETFs registered with SEBI—as a standalone category. The NDI Rules treated these unevenly; the Draft Rules harmonise their treatment.
– Partnership firms and proprietary concerns registered under applicable domestic laws. This is a notable expansion: under the NDI Rules, FDI into partnership firms was subject to significant restriction and required RBI approval. The Draft Rules appear to normalise such investment within the general framework, though the practical implications will depend on the sectoral conditions prescribed in Annexure-II (the FDI Policy).
Societies and trusts remain excluded, consistent with prior policy.
3. Revised Definition of ‘Equity’ (Rule 3(d))
The Draft Rules define ‘equity’ by reference to (i) instruments classified as equity under applicable accounting standards by the eligible investee entity (for non-investment-vehicle entities); (ii) units of investment vehicles under SEBI regulations; and (iii) participating interests or rights in oil fields or mines of an Indian company or LLP. The accounting-standard-based definition is a significant departure from the prior instrument-based enumeration (equity shares, compulsorily convertible instruments, etc.) and should reduce definitional disputes over the characterisation of novel instruments—though it shifts the primary classification question to the investee entity’s auditors and applicable Ind AS / IFRS standards.
4. Foreign Investment—Direct and Indirect (Rule 3(e))
The Draft Rules codify the concept of indirect foreign investment at the Rules level. A person resident outside India that invests through an FCE—or through another non-resident entity that it owns or controls—is treated as making a foreign investment. The ownership threshold for this purpose is beneficial holding of more than 50%, and the control threshold replicates the standard 10%-voting-rights-or-management-rights formulation familiar from the Companies Act and SEBI takeover regulations.
Notably, the Draft Rules do not define what happens when ownership and control point in different directions—a structuring question that arises regularly in sponsor-backed PE transactions and joint ventures. Practitioners should flag this gap for comment.
5. FDI vs. Foreign Portfolio Investment—Threshold Clarified (Rules 3(f) and 3(g))
The 10% threshold demarcating FDI from foreign portfolio investment is retained and now expressly applies to both companies and LLPs. The Draft Rules also provide, at Rule 8(1)(d), for the reclassification of foreign portfolio investment to FDI where a non-resident’s holding crosses 10%—requiring compliance with the applicable FDI conditions and directions of both the RBI and SEBI. This reclassification mechanism existed under the NDI Rules but is now more prominently articulated.
6. FCE Definition and Downstream Investment (Rule 3(h))
The definition of ‘Foreign Controlled Entity’ is retained with a materially important clarification: the determination of ownership and control for FCE purposes is to be governed by the applicable provisions stipulated by the respective sectoral regulator, in consultation with the Central Government. In the absence of sectoral regulator stipulations, the applicable domestic law governing the entity’s incorporation (Companies Act, LLP Act, SEBI AIF Regulations, as the case may be) will apply.
This is a sensible default hierarchy, but it creates a compliance monitoring challenge: FCE status—and therefore the downstream investment analysis for an FCE investing in Indian entities—will be determined by a patchwork of sectoral regulator positions rather than a single unified standard. For multi-layered holding structures, this layering of standards will require careful mapping at each level of the chain.
7. Regulatory Allocation: RBI and DPIIT (Rule 4)
Rule 4 formally allocates regulatory authority: the RBI administers the Draft Rules and may issue regulations, directions, circulars and clarifications for operational implementation; the interpretation of the FDI Policy and related directions remain with DPIIT. This codification is welcome but does not fully resolve the longstanding practical question of which regulator’s view prevails where the FDI Policy interpretation and FEMA compliance intersect—a question that arises regularly in approvals for government-route investments.
8. Modes of Acquisition and Transfer (Rules 6A and 7)
The Draft Rules consolidate the permissible modes of acquiring or transferring foreign investment: subscription, purchase, gift between natural persons (with conditions for repatriation-basis gifts to close relatives within LRS limits), pledge (subject to invocation compliance), and depository receipts under the DR Scheme 2014. The equity-swap mechanism is also expressly provided for—including, notably, a provision permitting investment vehicles to issue units to non-residents against a swap of SPV equity, which is relevant to InvIT and REIT M&A structures.
9. Direct Overseas Listing Scheme (Annexure I)
The most structurally novel element of the Draft Rules is Annexure I, which provides a FEMA-level framework for the direct listing of Indian companies on international stock exchanges. Key features include:
– Both listed and unlisted Indian public companies may list overseas, subject to eligibility conditions (no capital market debarment, no wilful default, no fugitive economic offender status) and compliance with the Companies (Listing of Equity Shares in Permissible Jurisdictions) Rules, 2024.
– Equity must be denominated in INR in the company’s books and held in dematerialised form through arrangements between Indian and foreign depositories.
– Foreign portfolio investment on international exchanges must comply with applicable sectoral caps. Beneficial ownership by Indian residents of such investments is prohibited—other than for registered broker-dealers or investment bankers acting in a custodial capacity.
– Transfer of internationally-listed equity from a non-resident to a resident is permitted only in defined circumstances: delisting, IBC resolution plans, buy-backs, mergers and succession/inheritance. This restriction will require careful analysis in secondary transactions.
– Pricing for initial listings by unlisted companies follows book-building on the relevant exchange; for already-listed companies, the price must be not less than the price applicable to the corresponding domestic issuance mode.
The ODI-like prohibition on Indian residents beneficially owning overseas-listed Indian equity is significant and may affect structures involving Indian-resident sponsors or promoters seeking to access international capital markets while retaining economic participation.
10. Pricing and Compliance (Rules 8 and 9)
Pricing guidelines are retained in substantially the same form: listed companies follow SEBI regulations; other cases require internationally accepted valuation methodology certified by a Chartered Accountant, Merchant Banker or Cost Accountant. Rights-basis subscriptions remain exempt from pricing guidelines. The onus of compliance is expressly placed on both the foreign investor and the eligible investee entity (or transferor/transferee), a formulation that preserves the dual-obligation structure familiar from the NDI Rules.
Way Forward
What the Draft Rules Get Right
– The affirmative, equity-focused scope definition removes a longstanding source of interpretive friction and provides a cleaner basis for instrument classification.
– The express inclusion of investment vehicles as eligible investee entities, and the equity-swap mechanism for InvIT/REIT transactions, reflects welcome regulatory maturation in the treatment of structured investment vehicles.
– The statutory codification of the RBI/DPIIT regulatory allocation—however imperfect—reduces the risk of regulatory forum shopping and provides a clearer basis for engagement with the respective regulators.
– The overseas listing scheme in Annexure I provides, for the first time, a statutory FEMA foundation for a transaction type that has until now rested on regulatory guidance. This should facilitate greater certainty for companies considering international capital markets access.
Open Questions and Practical Risks
– Indirect investment and FCE mapping: The accounting-standard-based equity definition, combined with the sectoral-regulator-determined FCE standard, creates a multi-layer classification exercise for every inbound investment through holding structures. Until the sectoral regulators issue unified standards, this will require case-by-case analysis.
– Partnership firms and proprietary concerns: The inclusion of these entities as eligible investee entities is potentially significant for sectors where such structures are common, but the applicable sectoral conditions in Annexure-II (the FDI Policy, not yet available) will determine whether this expansion is substantive or illusory.
– Ownership-control divergence: The Draft Rules do not address the scenario where the 50% ownership threshold and the 10% control threshold point to different conclusions about FCE status. This is a material gap for structured transactions.
– Overseas listing: The prohibition on Indian resident beneficial ownership of internationally-listed Indian equity requires careful structuring analysis for promoter-led international listings. The mechanics of compliance monitoring—particularly for secondary market transfers—are not yet articulated.
– Annexures II and III: The FDI Policy (Annexure-II) and the list of applicable RBI regulations (Annexure-III) are not yet available in the draft. These are operationally critical: the sectoral caps, entry routes and prohibited sectors—the substantive heart of the foreign investment framework—will be contained in Annexure-II.
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Disclaimer: The views expressed in this Update are solely those of the author and do not reflect the views of ICICI Group, or ICICI Bank or any of its affiliates. This update is prepared for general informational purposes only and does not constitute legal advice. Recipients should seek specific legal counsel before acting on any matter arising from this update. The Draft Rules are subject to change before enactment.
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