Raise Ceiling on Foreign Institutional Investment in Indian Companies

By Mukesh Butani —

SEBI Bhavan, the Head Office of Securities and Exchange Board of India in Mumbai, India. Source: Wikimedia user Jimmy Vikas, used under a creative commons license.

Status: Incomplete – While the Securities and Exchange Board of India (SEBI) has updated the foreign portfolio investment regulations in 2019, any reform to raise the ceiling on foreign institutional or portfolio investors has not yet occurred.

Low Difficulty: Regulation – Raising the ceiling on foreign institutional investors will require a regulatory decision by SEBI. This is usually done through a notification.

This is the twenty-first installment in a new series of articles on the India Reforms Scorecard: 2019-2024 by the staff and experts at the Wadhwani Chair in U.S.-India Policy Studies. The series seeks to provide analysis on why reforms marked as “Incomplete” or “In Progress” have not been completed, and the impact such reforms can have on specific sectors or the economy at large.

Foreign Portfolio Investment (FPI) flows have been an essential indicator of India’s economic parameters and strength of its capital markets, particularly debt markets, in the recent past. With India’s economic growth slowing in the past few quarters, SEBI has taken steps to liberalize FPI regulations. However, despite reforms, it has fallen short of increasing the 10 percent limit on FPI, limiting investment that this class of investors can provide in high growth Indian companies.

The process to formulate new regulations commenced in March 2018 with the constitution of a high-level Committee under the chairmanship of Mr. Harun R. Khan, the former deputy governor, Reserve Bank of India (RBI). Based on these recommendations, SEBI notified the public of new 2019 FPI Regulations (Regulations) on September 23, 2019, replacing its earlier set. On November 5, 2019, operational guidelines for FPI, Designated Depository Participants (DDP) and Eligible Foreign Investors were issued, laying down the process to implement the new FPI Regulations, 2019 while replacing all previous circulars.

New FPI/FDI classification

The new Regulations require that total investment of a single FPI, including its investor group in the equity of an Indian company, must be under 10 percent. Under the prior rules, classification of investments was determined by the route through which the investment was being made. Whereas under the new Regulations, if a foreign fund buys less than 10 percent stake in a company, such an investment would be considered FPI, regardless of the route chosen. In the event the total investment exceeds the 10 percent limit, FPI will be required to divest such excess holding within five trading days from the date of settlement of trades. In the event of failure to divest, its entire investment shall be characterized as foreign direct investment (FDI), which will be subject to sectoral guidelines. Subsequently, no fresh portfolio investments will be permitted by such FPIs, including its investor group.

This new FDI/FPI classification made by SEBI may hit several offshore funds because minority stakes in Indian corporations purchased by offshore funds through the FDI route may have to secure licenses as FPI. This further increase compliance and regulatory burdens.

Welcome Changes

Other changes made by SEBI in 2019 are a welcomed. These include the removal of the “broad basing” criteria, re-characterization of FPIs in two categories (as opposed to earlier three), and simpler Know Your Customer norms and compliance. FPIs have also been allowed to conduct off-market transfer of securities which are unlisted, suspended, or illiquid. This step addresses the issue of FPIs getting stuck with their holding as they could not sell the same on the exchange earlier. The government has also taken a step closer towards onshoring the offshore funds by updating the eligibility criteria concerning FPIs in international financial services centers.

Further, the opaque structure condition – mandating that DDPs are required to not have “opaque structure” has been removed in the amended Regulations. Such removal reduces unnecessary regulatory requirements and simplifies the compliance framework.

Overall these latest reforms in the FPI regulations come as a relief for FPIs as it shows SEBl’s mindset and its inclination to move beyond from its affinity for upfront documentation. They are also a testament to governments proactive engagement on tapping in foreign and offshore funds. The next logical step for SEBI should be increasing the FPI limit – as that is one area on which SEBI has remained static for few years now.

Mr. Mukesh Butani is a Non-Resident Senior Associate with the Wadhwani Chair in U.S.-India Policy Studies at CSIS, and the Managing Partner at BMR Legal. Follow him on twitter @mukeshbutani

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