The Reserve Bank of India (“RBI”) vide its circular dated May 21, 2024 (“Circular”),^[1] has required that issuance of partly paid-up units by Alternative Investment Funds (“AIFs”) to foreign investors prior to March 14, 2024, should be regularised through compounding under Foreign Exchange Management Act, 1999 (“FEMA”). Compounding by RBI is prescribed for the contravention of foreign exchange regulations as per Foreign Exchange (Compounding Proceedings) Rules, 2000, and involve payment of a fees. In many instances, compounding requires payment of a monetary penalty to RBI.

On March 14, 2024, the Government of India had amended the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (“NDI Rules”) vide the Foreign Exchange Management (Non-debt Instruments) (Second Amendment) Rules, 2024, to permit issuance of partly paid-up units by investment vehicles (including AIFs) in accordance with applicable SEBI regulations. The compounding process may add to compliance costs and AIFs may be required to make disclosures.

Analysis

The SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”), did not explicitly bar AIFs from issuing partly paid-up units to their investors since inception. Further, SEBI vide its SEBI (AIF) (Fourth Amendment) Regulations, 2018 (effective from 2021), explicitly clarified that AIFs may issue partly paid-up units by revising the definition of the term “units.” Similarly, the NDI Rules did not bar issuance of partly paid-up units by investment vehicles (including AIFs). Further, as per the notification titled “Foreign Investment in India-Reporting in Single Master Form” dated June 07, 2018,[2] and Foreign Exchange Management (Mode of Payment and Reporting of Non-Debt Instruments) Regulations, 2019, investment vehicles (including AIFs) were mandated to file “Form InVi” within 30 days from the issue of units to the foreign investors. The Form InVi did not bar AIFs to issue partly paid-up units to its foreign investors.  

During mid-2023, reports emerged that Authorised Dealer Banks (“AD Banks”) were not accepting Form InVi for issuance of partly paid-up units by AIFs to their foreign investors. This led to a modification in Form InVi restricting AIFs from issuing partly paid-up units to their foreign investors. Media reports highlighted several representations the AIF industry made to RBI requesting the resolution of this issue.

Following the amendment to the NDI Rules on March 14, 2024,[3] allowing issuance of partly paid-up units to persons resident outside India by investment vehicles (includes AIFs), RBI vide its Circular required compounding for issuance of partly paid-up units before the date of the amendment. However, before approaching RBI for compounding, AD Banks have been directed to ensure that the necessary administrative action, including the reporting of such issuances by AIFs to RBI, through Foreign Investment Reporting and Management System (“FIRMS”) Portal and issuing of conditional acknowledgements for such reporting, is completed. Further, the AD Banks may bring the contents of the Circular to the notice of their customers/constituents concerned.

We suggest allowing compounding under the Circular from mid-2023, after the revision of Form InVi, instead of a blanket implementation, considering the NDI Rules or Form InVi had no restrictions on compounding for the issuance of partly paid-up units.

[1] RBI/2024-25/36, A.P. (DIR Series) Circular No. 7.

[2] RBI/2017-18/194, A.P. (DIR Series) Circular No. 30.

[3] S.O. 1361 (E), Notification, Ministry of Finance (Department of Finance).