The Third Lane: RBI's FCE Classification Gap

[Neeve is a student at Gujarat National Law University.]

Recently, the Reserve Bank of India (RBI) released the draft Foreign Exchange Management (Foreign Investment) Rules 2026 to replace the NDI Rules 2019 (Rules), built around one central idea. Rule 4 of the draft split’s regulatory authority into two lanes. While RBI administers the Rules themselves and can issue directions, circulars, and clarifications for their implementation. Interpretation of the foreign investment policy, sectoral caps, sectoral conditions, entry routes, is carved out separately and vested entirely in the Department for Promotion of Industry and Internal Trade (DPIIT). The draft's own stated objective is to make this separation clean enough that policy can change without disturbing the Rules, and the Rules can be applied without waiting on policy.

The architecture presumes that there will be a sorting mechanism for every question arising from the draft, as well as an arbitrator in case of a conflict between the two lanes. There is none for a very important question which is what constitutes “foreign controlled entity” (FCE) i.e., the very basis for applying sectoral conditions to it. It is neither decided by the RBI nor the DPIIT. Rather, it is decided by “the respective sectoral regulators,” an entity never considered in the two-lane model at all, with a fallback to ordinary company law where no sectoral regulator has spoken.

The Lane Nobody Assigned

This whole setup assumes there's always a clear place to send a question, either to RBI or to DPIIT, and someone to turn to if the two disagree. For one question that actually matters a lot, there's neither.

Whether an entity counts as a "foreign controlled entity" decides which sectoral rules apply to it in the first place, under Clause 8(1)(a). But the test for that status doesn't come from RBI's side or DPIIT's side. Clause 3(1)(h) says ownership and control, for this purpose, are decided by "the applicable provisions stipulated by the respective sectoral regulators," and only falls back to the Companies Act 2013, the Limited Liability Partnership Act 2008, or Securities and Exchange Board of India's Alternative Investment Fund framework if no sectoral regulator has said anything at all.

This leaves a binary ambiguity: if 'stipulated' means a sectoral regulator's existing written rules, DPIIT would need to interpret those rules under Rule 4(2), but the draft never says so; if it means the regulator's own ongoing judgment in individual cases, that regulator is acting as a third policymaker Rule 4 never assigns that role to.

Even on the narrowest reading, that a sectoral regulator's existing written rules are what's meant, and not any ongoing say in individual cases, this still doesn't sit neatly in either lane. The task of DPIIT, in accordance with Rule 4(2), is to interpret the policy of foreign investment. Therefore, in the context of uncertainty in the rules of the sectoral regulator in relation to the definition of the concept of control, which, according to the draft, directly affects the issue of applying sectoral conditions, the draft does not answer the question of who interprets the term control: DPIIT, the sectoral regulator, or possibly RBI, since it also has the competence to interpret the Rules in accordance with Rule 4(1) is not entirely clear. The draft built two lanes, and left out exactly the place where they need to meet.

An Obvious Defence?

Two responses to this criticism deserve detailed examination here, rather than dismissal.

The first concerns whether it's appropriate to let sectoral regulators run their own control tests and simply rely on the result when applying the FCE test, in effect deferring to their expertise. This is largely a valid point. The Companies Act 2013's control test is not some random fallback; it is the language that has consistently been used in regulating foreign investment control questions, and its clearly what Clause 3(1)(e)'s own definition of control is modelled on. So, neither prioritising the sectoral regulator's test nor falling back on company law is, in itself, an unusual choice.

However, that is not really where the problem lies. Clause 3(1)(h) also says the test is to be established "in consultation with the Central Government," which places the same problem in a different spot. This phrase does not specify which government agency is meant, while Rule 4(2), just one clause away, names DPIIT specifically wherever the draft intends DPIIT. It does not do that here, so even the formation of the test involves some governmental actor whose identity is left unstated, on top of a structure that already says nothing about what happens if that test turns out unclear, or conflicts with how DPIIT reads a related sectoral condition. Choosing sensible sources for the test does not resolve either problem. Somebody still has to be the one who steps in when things are unclear, and the draft never says who.

There is also a question of whether DPIIT could step in here even if it wanted to. This power of DPIIT under Rule 4(2) includes interpretation of the policy on foreign investment itself, which is found in Annexure II. The FCE test, in turn, sits in the definition clause under Rule 3. Therefore, DPIIT's interpretation of the sectoral regulator's test of foreign character of investments will be its interpretation of the Rules, which 4(2) does not grant it explicitly. Neither body holds clear title to the question.

The second argument is that such an ambiguity can be resolved later on by way of a circular or any other kind of clarification issued by the regulator, so it does not matter that there is nothing written in the Rules about it right now. While that could certainly be true, this actually confirms rather than denies the criticism. Indeed, if the matter is supposed to be eventually settled by some future clarifying document, not by the language of the rules themselves, then the whole point of the Rule 4 that the draft claims to establish, namely predictability of the process, does not hold up here. Ambiguity that gets resolved later by whichever of the two bodies gets around to it first is obviously far from predictable. For the foreign investor, this is not an academic exercise, since it involves confronting the views of the sectoral regulator on FCE status, DPIIT's interpretation of the sectoral condition, and RBI's implementation of rules that leave final say to neither body.

The Simple Fix

None of this suggests that the sectoral-regulator-first approach should be scrapped. It just needs to be completed. Rule 4 could add a further sub-rule that where a sectoral regulator's stipulated control test is unclear, or inconsistent with that applicable to it by virtue of a sectoral condition specified by DPIIT, the two shall jointly determine it within a specified period, failing which reference shall be made to a specific appellate authority for its binding determination so as to remove any ambiguity or inconsistency between regulatory regimes.

The RBI already has everything it needs for the purpose. It has a standalone control test; policy authority sitting with DPIIT; and administrative authority over the rules. All it needs is for one specific lacuna to be filled, namely, who takes charge in case of conflicting or inconsistent sector-specific interpretations of the control tests. This is a reform that should not be left dangling.