In June 2024, the Reserve Bank of India (RBI) issued a long-awaited circular that relaxed regulations surrounding investments in overseas funds. This circular allows Indian Limited Partners (LPs) to invest in overseas funds regulated through their regulated investment manager, eliminating the previous requirement that investments could only be made in funds directly regulated by the host country’s financial regulator. Additionally, it removes restrictions that previously limited Indian LPs to investing solely in units issued by overseas funds, thereby broadening the range of investment instruments available in fund vehicles.
The circular streamlines and eases the existing regulations, allowing Indian resident investors and companies to participate in overseas investments more easily, particularly in carry and co-investment contributions within offshore/overseas fund vehicles like Overseas Portfolio Investment (OPI).
Pre-liberalisation framework
Previously, Overseas Portfolio Investment (OPI) was authorized solely when the funds were regulated in their home jurisdiction, and the investments were made in units of these funds, as per the overseas investment framework of 2022. This framework is a comprehensive understanding of both the Foreign Management (Overseas Investment) Rules, 2022 (OI Rules), and the Foreign Exchange Management (Overseas Investment) Directions, 2022.
The OI Directions had established a pathway for unlisted Indian entities, listed Indian companies, and resident individuals to engage in Overseas Portfolio Investment (OPI) in overseas funds. Nevertheless, this authorization was contingent upon two conditions: the investment had to be in units of the overseas funds, and the fund itself had to be regulated in its host jurisdiction.
The wording of the framework was restrictive, leading to confusion among authorized dealer banks about whether investments in forms other than units of overseas funds were permissible. This ambiguity resulted in several offshore fund vehicles, structured as corporate entities issuing shares, stocks, partnerships, or membership interests instead of trusts issuing units, being excluded from receiving Overseas Portfolio Investment (OPI).
Hence, authorized dealer banks typically allowed remittance only if the fund was directly regulated and not through its manager. This approach led to challenges for Indian Limited Partners (LPs) in fulfilling their pre-framework capital commitments, especially when the fund was situated in a jurisdiction where its financial sector regulator did not have significant oversight and was regulated primarily through its manager.
The amendments: Nature of instrument and Regulation of fund
Given the circumstances outlined above, numerous requests for clarification on the framework and improvements in business operations were submitted to both the Ministry of Finance and the RBI. In response, the RBI made revisions to Paragraph 1 (ix) (e) and Paragraph 24 (1) of the OI Directions, eliminating the restrictions and considering the varied legal and regulatory frameworks governing investment funds across different jurisdictions.
The revised paragraph states that investments, including sponsor contributions, in units or any other form of instrument (regardless of name) issued by an overseas investment fund regulated by the financial sector regulator in the host jurisdiction will be considered Overseas Portfolio Investment (OPI). This means that besides investing in units of offshore investment funds in IFSC, investments are now allowed in any other instruments issued by such offshore funds in IFSC. This broadens the legal structures eligible for OPI from traditional trusts issuing units to funds structured as Limited Partnerships (LPs), General Partners (GPs) of PE/VC funds, LLCs, VCCs, and other corporate entities. Consequently, this revision facilitates OPI for entities previously excluded by authorized dealer banks due to prior restrictions.
Additionally, the paragraph clarifies the definition of a duly regulated overseas investment fund for the purpose of the aforementioned provision. It includes funds whose operations are regulated by the financial sector regulator of the host country or jurisdiction via a fund manager. As a result, the RBI has given flexibility to General Partners (GPs) in establishing funds in jurisdictions with favorable commercial conditions by allowing Overseas Portfolio Investment (OPI) in overseas funds regulated through their managers. This change will also enable Indian resident individuals and Indian listed companies to engage in OPI without any ambiguity regarding both the regulation of the fund and the type of instrument issued. This aligns with the treatment of Limited Partner (LP) investments in funds in IFSC GIFT City, where OPI is permitted even if the funds are not directly regulated.
Conclusion
The RBI’s liberalization of regulations pertaining to investments in overseas funds, particularly with the amendment of Paragraph 1 (ix) (e) and Paragraph 24 (1) of the OI Directions, marks a significant shift towards facilitating easier participation of Indian investors in global markets. These revisions not only broaden the scope of eligible investment instruments but also address ambiguities and hurdles previously faced by Indian stakeholders, thus fostering a more conducive environment for Overseas Portfolio Investment (OPI) activities.
