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FPI: Beware Unintended Consequences

Published on Thu, Jul 25,2013 | 14:04, Updated at Thu, Jul 25 at 14:09Source : 

By: Ajay Vaidya, Chief Legal & Compliance Officer, Kotak Mahindra Capital

The Chandrasekhar Committee has recommended some measures to rationalize Portfolio Investment Routes in India.

This article is limited to investments in equity shares and convertible debentures. Given below is a comparison chart of the current routes and changes proposed.

Investment Route

Investment Limits

Proposed Class of investor

New Investment Limit

Foreign Direct Investment Scheme  (“FDI”)


Upto sectors caps. No individual investor limit

No change as the committee report does not cover FDI investments except for classification of portfolio investments beyond 10% as a FDI investment

Remains unchanged.


Foreign Institutional Investor (“FII”)

10% of paid capital per FII and sub account except 5% for sub accounts registered in the category as foreign individuals & corporates

Upto  aggregate of 24% of a company which can be increased upto sectoral caps by passing a shareholders resolution



FII and QFI to be merged as one category to be called Foreign Portfolio Investor (“FPI”)

Investment Limit

10% per investor and the lower of 24% in aggregate or sectoral cap in respect of each class of equity share class having separate ISIN. (where more than  one FPI  have same  common beneficial  owner, all such FPI shall together be  treated as  one FPI for the purpose of investment limit)


Qualified Foreign Investor

5% per QFI . 10% in aggregate

Non Resident Indian (“NRI”)

5%  per NRI and 10% in aggregate 10% which can be increased to 24% with shareholders approval

No Change

No Change

Foreign Venture capital Investor  (“FVCI” )

Atleast 66.67% of investible funds  in unlisted equity shares or equity linked instruments


33.33 % in IPO  of companies whose shares are to be listed and in preferential offers of listed companies besides debt of investee companies.







No change







No change

Non Resident Indian- Non Repatriation  basis

  No limits

No Change

No change





































If the committee recommendations are adopted the aggregate automatic limits for the two classes ( FII  & QFI) will get reduced from the current aggregate  limit of  34% (24+10)  to 24% for all FPIs.

Currently portfolio investments made by FII do not attract the FDI qualifying conditions as applicable to a sector; as a result, FIIs can invest in a Company upto 10% and in aggregate 24% in those companies.  By  specifying the limit would be the lower of 24% and sectoral cap, I would think portfolio investments in companies that do not meet qualifying conditions would in the new regime not be possible beyond 10%. It is assumed that all portfolio investment conditions remain unchanged on the new classification of investments based on the 10% cutoff as a deemed portfolio investment.

The new regime proposed that registration of FIIs be moved from SEBI to Designated Depository Participants (“DDP”).  While this may seem like an easing of the registration process, I am not sure whether it will end up having that desired effect. Currently a FII sub account can register with SEBI... and get broad based, within 90/180 days, by getting in investors within that time. This enables a FII to start investing in India from day one of getting funds. I’m not sure DDPs will have the same flexibility. Who will approve a merger of two FPI investors? I suppose it would still have to be SEBI. Consider another situation - limits in FPIs having common investors in a fund are to clubbed.  Here, I suspect a DPP may not do a materiality test and may delay or deny registration. Also, consider practical issues that a DPP would have to consider and exercise independent judgment on, while registering a FPI. Like a foreign mutual fund having some NRIs investors or even resident Indian investors (such investments by resident Indians are permitted under the RBI liberalized foreign investment scheme)? Hence, guidance would be required such that a threshold limit is established.

Currently some FII funds have more than one registration with SEBI (with an aggregate cap of 10%) as they have multiple managers for sub-funds.  How will this work in the new regime? It would be a tough ask to expect a DPP to permit such multiple registrations by one fund.

I presume DPPs will be given the responsibility (currently with SEBI) of maintaining current data on a FPI’s registered address, Directors... It’s not clear how change in control of ownership of a fund will be dealt with. I also think reliance on a global custodian for KYC gives a clear benefit to foreign brokerages for on-boarding clients, as they may not be willing to give the same declaration to Indian brokers.

Most countries encourage their non-residents to invest in the country by offering a more liberalized regime than foreigners. So should India. In addition, the NRI investment regime suffers from historical baggage on fears by Indian Promoters of their companies being taken over. Currently, a NRI investment of even one share in an IPO is FDI while for FIIs it qualifies as portfolio investment. Total FII investments in a company can go beyond 24% with shareholder approval whereas total NRI limit can only be increased from 10% to 24% with shareholder approval. I presume hereon the confusion on foreign companies owned by NRI goes away and all such companies not classified as OCB will be considered foreign companies.

While the separate classification of FII and QFI is to be removed and that may appear to make for a simpler regime, the actual trading mechanics may still not be the same for all.  I do not foresee non-institutional investors being permitted to use Direct Market Access (DMA) and any further sophisticated electronic trading facilities permitted by SEBI/Stock Exchanges. Will all investors under FPI be permitted to trade in derivatives and use stock borrowing and lending facilities? Also will the trading margin requirements of Stock Exchanges be the same for all FPIs?

Further, FII and most sub accounts are recognized as Qualified Institutional Buyers (QIB) for capital raising under SEBI (Issue of  Capital & Disclosure Requirements) Regulation, 2009. For instance IPO of companies that do not have a track record need a minimum 50% QIB investment to get listed. Only QIBs can participate in Qualified Institutional Placements and Institutional Placement Programmes. Will the FPI be a QIB? In my view, that’s very unlikely.

The last point I’d like to make is regarding the classification between FDI and Portfolio investments. The report mentions the following:

  • Investments in unlisted securities, regardless of the level of ownership that they represent, shall be regarded as FDI.
  • Where there is an FDI investor, all equity holdings of such an investor in the concerned company, regardless of the manner in which such equity holdings have been acquired, should be classified as FDI.
  • Where an investor initially acquires less than 10 percent of the voting equity of an Indian company and thereafter acquires additional equity which takes the investor’s aggregate holding to over 10 percent, in such a scenario, all of the investor’s holdings should be classified as FDI.
  • Where an investor has FDI holdings in excess of 10 percent of the voting equity of a company, it should retain its FDI classification even if the investor were to dilute his holding to a level below 10 percent of the voting equity of the company.
  • Will the 10% be calculated for a single investor or on a group basis? What happens if on reclassification after crossing the 10% threshold, the FDI investment does not conform to qualifying conditions such as minimum capitalization? Will these investments become illegal? Classification of investments up to 10% as portfolio investments will not substantially improve investment opportunities as investments in all unlisted companies will be now be FDI.

To conclude the broad idea of rationalization looks like a positive step but implementing it without extensive interaction with market participants, a complete crossing referencing of all existing rules and regulations, a detailed study of taxation and bilateral investment treaties impact,  may cause serious implementation issues resulting in unintended consequences.     

Views here are personal


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