India Targets Foreign Portfolio Investments for Ease of Doing Business

By Dezan Shira & Associates
Editor: Tracie Frost

The Indian rules for foreign portfolio investments (FPIs) have undergone several regulatory changes designed to ease investment in the last few years.  FPIs primarily consist of securities and other financial assets passively held by foreign investors, generally for short-term speculation. Foreign portfolio investment differs from foreign direct investment in that it does not give the investor direct ownership of financial assets.

Prior to January 2014, FPIs were divided into foreign institutional investors, qualified foreign investors, and sub-accounts.  Responding to market pressure, in January 2014, the Securities and Exchange Board of India (SEBI) notified new rules which were designed to bring India in line with international norms and establish a simplified regulatory framework for foreign investors who fit the FPI framework.  The new rules merged foreign institutional investors, qualified foreign investors, and sub-accounts together to form the new foreign portfolio investor class.  The rules took effect on June 1, 2014.

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The SEBI divided FPI into three categories based on risk:

Category I (low risk) includes government and government-related investors such as central banks, governmental agencies, sovereign wealth funds, and international or multilateral organizations or agencies.

Category II (moderate risk) includes regulated entities such as mutual funds, investment trusts, insurance companies, banks, asset management companies, portfolio managers, and university endowments.

Category III (high risk) includes all investors not eligible under Category I and II such as charitable societies, charitable trusts, foundations, corporate bodies, individuals, and family offices.

Under the regulations, total investment by each FPI is restricted to 10 percent of the issued equity capital of the company. However, aggregate FPI investment in an Indian company is capped at 24 percent, unless specifically authorized by that company’s board of directors.  FPIs are not generally allowed to invest in unlisted shares. 

In July 2015, the Indian government instituted composite caps to increase the aggregate limit of 24 percent up to the sectoral cap/statutory ceiling provided in the consolidated foreign direct investment policy.  These rules abolished sub-limits on different categories of investment and instead created overall caps for foreign direct and foreign portfolio investment.  FPIs may now invest up to the sectoral cap in any company as long as the investment has been authorized by the company’s board of directors, and, if necessary, approved by the Indian Government.  

Again, in September 2015, the Government of India responded to investor concerns by affirming that FPIs are not liable for minimum alternative tax (MAT) in India if they have no permanent establishment or place of business in India. The clarification was a welcome announcement to FPIs who had been issued notices seeking payment of MAT.   

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Observations

While these changes in foreign investment policy have improved the investor landscape for foreign entities, investors say that more changes are necessary to increase India’s ease of business and bring more foreign portfolio investment to India.  Recently, SEBI has signaled the possibility of creating most favored nation status for investors from the U.S., Canada, Japan, and Europe.  Investors from these countries could be accorded automatic approval, much like the process for foreign direct investment.

SEBI could also consider ways of accommodating investors who are not members of international securities bodies or regulated by a central bank, including Middle Eastern sovereign wealth funds and state-regulated U.S. banks.  Currently these investors can only trade in India as Category III funds, which are not allowed to issue derivative instruments.  SEBI requires that funds be regulated by the securities market or banking regulators of their country in order to be Category I or II funds.   

As India continues to improve the ease of foreign portfolio investors to enter the Indian market, greater investments should follow.

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