Introduction
India’s foreign investment landscape has undergone considerable regulatory changes in the last decade or so, which is a reflection of India’s constant commitment towards developing itself as a significant investment destination on the global scene. There are various aspects of the foreign investment landscape in India, and the downstream investments of Foreign Owned and Controlled Companies (FOCCs) have received considerable regulatory attention in recent times due to the fact that downstream investments of FOCCs offer a significant opportunity to channelize existing investments in India into other domestic companies.
However, in spite of the critical nature of the downstream investments of FOCCs in the foreign investment scenario in India, the regulatory scenario with regard to FOCCs has traditionally been marked with ambiguity and complexity. The recent developments with regard to the regulatory aspect governing foreign investments in India, such as the Foreign Exchange Management Act, 1999, and the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019, are a reflection of the efforts of the government to address the regulatory complexities with regard to FOCCs in India. On January 10, 2025, the Reserve Bank of India notified the Master Direction on Foreign Investment in India, which included certain clarifications to the downstream investments of FOCCs.
This blog aims to outline the regulatory treatment of downstream investments of FOCCs in India and the recent regulatory changes to the same.
Understanding FOCCS and Downstream Investments
Foreign Owned and Controlled Company (FOCC) is an Indian company that is either owned or controlled by persons resident outside the country. Non-residence is generally determined based on the ownership of more than 50% of the equity capital of the company located in India by persons resident outside the country. Control, on the other hand, can be determined if the non-resident shareholders possess the authority to appoint the majority of the directors of the company.
Downstream investment refers to an investment made in another Indian company by an FOCC in the form of acquisition or subscription of capital instruments such as equity shares or compulsorily convertible preference shares.
In effect, the concept of downstream investment provides scope for indirect foreign investment in the country, as the capital invested in the second Indian company is made through an intermediary Indian company that is foreign-owned or controlled.
The Indian regulators have always been guided by the principle of “what cannot be done directly should not be done indirectly.” As a consequence, the downstream investments made by the FOCCs are required to adhere to the same entry routes, sectoral caps, pricing guidelines, etc., as are applicable in the case of direct foreign investments.
Evolution of the Regulatory Framework
The regulatory regime governing the downstream investment has been primarily governed by the FEMA regime, coupled with the NDI Rules. Over the years, it has been realised that the regulatory regime governing the downstream investment has created ambiguities in the minds of the companies in structuring the investment agreements in the form of share swaps, deferred payments, etc.
However, an important step has been initiated in the direction of regulatory clarity in the form of amendments to the NDI Rules in the year 2024, followed by the RBI revisiting the Master Direction in January 2025, which has attempted to harmonise the treatment of downstream investments in consonance with the FDI policy, thereby removing the ambiguities in the regulatory regime governing the same.
The amended framework also further clarifies that investments made by FOCCs through different routes, such as equity share swaps and deferred payments, are permissible, provided these investments are consistent with the guidelines on pricing, sectors, and reporting. The changes appear to be aimed at striking a balance between the treatment of FOCCs and direct foreign investors.
Key Regulatory Challenges in Downstream Investments
Despite these recent changes, a number of regulatory challenges still exist with respect to downstream investments made by FOCCs. The challenges are mostly related to interpretational, compliance, and structural issues.
1. Ambiguities in Transaction Structures: One of the most pertinent regulatory challenges faced by FOCCs has been the lack of regulatory clarity on the structures and mechanisms applicable to FOCC transactions. For example, the regulatory clarity on the use of share swaps in FOCC transactions and the use of deferred consideration structures in M&A transactions.
Share swaps are most commonly seen in cross-border M&A transactions where the acquiring company wants to raise funds and use a share-based consideration mechanism rather than a cash-based mechanism. Deferred consideration structures like escrow, milestone-based considerations, and indemnity-based holdback are commonly seen in M&A transactions and are usually applied to the allocation of risk.
However, the lack of regulatory clarity on the use of these structures and mechanisms has forced companies to seek regulatory guidance on these issues, even though they are not formal regulatory guidelines. This has resulted in higher costs being incurred on these transactions. However, with the recent Master Direction on the regulatory guidelines on M&A and FOCC transactions, regulatory clarity has been provided on the use of these structures and mechanisms, and share swaps and deferred consideration structures are allowed. However, regulatory uncertainty still exists on the use and applicability of these structures and mechanisms
2. Restrictions on the use of Domestic Borrowings: Another significant regulatory restriction that FOCCs face relates to domestic borrowings made for downstream investments. The regulatory restriction has been imposed so that there is no round-tripping, where foreign investors use domestic borrowings for making investments.
In such a case, FOCCs will be required to fund downstream investments either through foreign equity investments or internal accruals obtained from the company. Domestic borrowings obtained from Indian financial institutions cannot be made for downstream investments.
This rule, though it increases transparency and ensures that all downstream investments are made in actual foreign capital, can limit the flexibility of companies relying on the domestic credit system.
3. Pricing and Valuation Constraints: Pricing guidelines are another important regulatory issue that companies have to deal with while undertaking downstream investments. Pricing guidelines have to be followed while undertaking any transactions involving capital instruments.
For a listed company, it would be imperative for the pricing of the investment to adhere to the guidelines set by the Securities Exchange Board of India. In an unlisted company, it would not be possible for the pricing of the investment to be at a value lower than the fair market value based on methodologies accepted globally. While these guidelines are imperative for transparency in downstream investments, they can be limiting for the company in its commercial flexibility.
4. Reporting and Compliance Burden: Another significant regulatory challenge faced by companies making downstream investments is the compliance and reporting burden. As part of the reporting guidelines, an Indian company making a downstream investment is required to file Form DI within thirty days of making the investment. However, the situation can get complicated when an Indian company has already made a downstream investment and then becomes an FOCC due to a change in the shareholding structure. In such a situation, the investment would now qualify as a downstream investment and would thus require fresh reporting.
These compliance guidelines would require the company to maintain proper internal systems for monitoring the changes in the shareholding structure of the company.
5. Limitations on Deferred Consideration Structures: Although a regulatory framework has been established to permit deferred consideration structures, they are still subject to certain limitations and restrictions. The so-called “18-25 rule” allows a maximum deferral of 25 per cent of the overall consideration received in a deal for a period not exceeding 18 months from the date of entering into a transfer agreement.
Although this provision takes into consideration the commercial realities associated with M&A transactions, such a stipulation may not always be in line with the time scales applicable to such transactions.
Recent Regulatory Developments
The revised master direction introduced in 2025 has been a welcome step in surmounting these hurdles and challenges.
First and foremost, a regulatory framework has been introduced, which has recognised the potential of FOCCs to make downstream investments with the help of share swap mechanisms. This has provided a boost to cross border M&A and joint ventures, especially with the fact that equity instruments can be used as a mode of consideration in M&A transactions.
Secondly, a regulatory framework has been introduced, which has formally recognised the permissibility of deferred payment structures such as the use of escrow and milestone payments.
Thirdly, a revised framework has been introduced to improve the compliance requirements, especially with regard to Form DI.
In essence, these developments indicate a shift in regulatory policy, moving from a conservative approach to a more liberal approach, considering the commercial realities associated with M&A transactions and downstream investments.
Conclusion
Though significant clarity has been achieved in the framework of downstream investments undertaken by FOCCs due to the recent spate of regulatory reforms, further enhancements are necessary to ensure that the foreign investment regime in India is “efficient, predictable, and ‘investor-friendly’.” More regulatory guidance on the “practical implementation” of downstream investment regulations is necessary to avoid interpretational ambiguities and ensure uniform compliance practices among authorized dealer banks. Further, better “harmonization” of FEMA regulations, consolidated FDI policy, and investment guidelines is pertinent to avoid fragmentation.
Regulators also need to take a pragmatic approach to new and complex transactions such as earn-outs, contingent considerations, and convertible instruments, commonly used in global M&A deals. However, companies also need to improve their internal compliance processes through close monitoring of changes in control, compliance with disclosure timetables, and regular legal audits.
In short, a more transparent and flexible system will allow the FOCCs to make downstream investments with more certainty, thereby facilitating the inflow of foreign capital into the country and contributing to its long-term growth.
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