Global PE funds with Chinese LPs hit compliance hurdle despite FDI rule easing

Global PE funds with Chinese LPs hit compliance hurdle despite FDI rule easing

Global private equity funds with minority Chinese investors are finding it difficult to make sub-10 percent investments in Indian companies despite the government relaxing foreign direct investment (FDI) rules in March, as complex disclosure requirements make it difficult to establish that they qualify for the exemption.

In March 2026, the government eased restrictions under the Press Note 3 framework to allow certain investments involving less than 10 percent Chinese beneficial ownership through the automatic route, provided such investors do not exercise control, have board representation or enjoy special rights in the Indian company.

The change was expected to make it easier for global investment funds with small or passive Chinese limited partners (LPs) to deploy capital in India without seeking government approval.

In practice, however, the problem has shifted from whether Chinese ownership is below the prescribed threshold to whether funds can prove that it is.

To comply with the requirements, both the investing fund and the Indian investee company have to give undertakings regarding Chinese ownership and control. They also need to determine whether a Chinese investor in the fund separately holds a beneficial interest in the company through another investment vehicle.

This can require funds to conduct a look-through exercise covering their LPs and, in some cases, the investors behind those LPs.

Compliance challenges

For a global PE fund whose investors include pension funds, sovereign wealth funds, fund-of-funds and other large institutions, establishing the ultimate ownership can be difficult. An LP may itself be an investment fund with hundreds of underlying investors whose identities may not necessarily be available to the PE fund making the investment in India.

The safe harbor isn't a threshold test, it's a disclosure test. Both the fund and the investee company must certify, on a look-through basis, at every ownership tier, that no Chinese investor holds control or crosses 10 percent effective interest.

For a diversified LP base — pension funds, SWFs, fund-of-funds — that means unwinding confidentiality commitments made to investors who never agreed to have their identity disclosed to a third jurisdiction's regulator. 

The compliance challenge is particularly relevant for large global PE funds because their capital is typically pooled from institutional investors across several jurisdictions. While identifying direct Chinese LPs may be relatively straightforward, tracing beneficial ownership through multiple layers of investment vehicles can be significantly more difficult.

In some cases, the investing fund may neither possess the information required to make such a declaration nor have the contractual or legal ability to compel an underlying fund or institution to disclose its investors.

Data privacy and confidentiality requirements in overseas jurisdictions can add another layer of complexity.

Press Note 3 got the policy right by tying Chinese ownership to a clear 10 percent threshold under PMLA rules. The problem lies in proving it.

The funds and investee companies need to certify this threshold, even though neither has the legal power to force secondary investors to reveal who they are. Furthermore, staying under 10 percent doesn't exempt them from the process — the entity must still prove and report the linkage through its bank.

The result, with such transactions, is that some global PE funds that may have only a small Chinese LP exposure are still finding it difficult to make investments through the automatic route despite the relaxation.

Ownership tangle  

The situation highlights a gap between the intended policy relaxation and its implementation for global pools of capital with complex ownership structures.

Press Note 3 was introduced in April 2020, when India made prior government approval mandatory for foreign direct investments from countries sharing a land border with India, or where the beneficial owner of an investment was situated in or was a citizen of such a country.

While the framework covers all countries sharing a land border with India, its most significant impact was on investments involving China and Hong Kong because of the amount of capital originating from those markets.

The restrictions were introduced during the early months of the Covid-19 pandemic amid concerns over opportunistic acquisitions of Indian companies. The deterioration in India-China relations following the Galwan Valley clashes in June 2020 subsequently resulted in greater scrutiny of economic ties between the two countries.

The framework also led to a large number of foreign investment proposals requiring government scrutiny, resulting in a backlog of applications.

According to reports, more than 600 applications under the Press Note 3 framework were pending with the government, while only one proposal was approved during FY26.

The March relaxation sought to address part of this problem by creating an easier route for investments where Chinese participation was small and passive, while retaining government scrutiny for investments involving more significant ownership or control.

For private equity funds, the distinction is important because the Chinese investor may have no direct connection with the Indian company receiving the investment.

A Chinese institution could, for instance, be one of several investors in an overseas fund, which in turn invests in another fund that eventually deploys capital in an Indian company. Establishing the effective beneficial interest through such layers can require information that the PE fund at the end of the chain may not have access to.

Consequently, even where the ultimate Chinese exposure is likely to be below 10 percent, the inability to conclusively establish and certify that ownership can make it difficult for a fund to rely on the automatic route.

The March changes may have lowered the ownership threshold-related barrier for global funds with minority Chinese LPs. For some investors, however, demonstrating that they meet the conditions of the exemption is emerging as the bigger hurdle.