Implementing the change announced in India’s budget for 2016-17, the Reserve Bank of India (RBI) on 9 September liberalized the norms for foreign direct investment (FDI) in the financial services sector. The effect is a paradigm shift from prescribing an exhaustive list of 18 financial services activities to prescribing an inclusive set of permitted activities.
Previously, the FDI policy covered only 18 financial services under the automatic route. FDI in other unspecified financial activities was considered under the approval route. Absence of any explanation on the scope of the 18 specified activities often resulted in confusion over what activities were permitted to receive FDI under automatic route.
Limited policy evolution – such as the clarification that insurance broking, trusteeship services, estate planning services, operating leases, etc., do not fall under the scope of “financial services” – was an outcome of deliberations on applications by potential investors to the Foreign Investment Promotion Board (FIPB). Such applications demonstrated the policy ambiguity that troubled the sector, and hurt investor sentiment.
Accordingly, after a long wait, the narrow list of permitted activities has been eliminated. Instead, FDI will be allowed, under the automatic route, in any activity that is regulated by a financial service regulator. This not only expands the field of financial services activities, but also creates a self-evolving regulatory regime that ensures the inclusion of any new regulated financial services activity under the automatic route.
The change also eliminates the mandatory minimum capitalization norms (ranging from US$500,000 to US$50 million) prescribed under the erstwhile regime. This move is welcome as the norms weren’t made-to-measure to suit different types of activities, and were often inconsistent with the requirements of the sectoral regulator or business needs.
The change will also facilitate M&A activity in the sector, as the minimum capitalization norms will neither apply to first level investment nor to downstream investment arising upon acquisition of a non-banking financial company (NBFC) by another NBFC (with foreign investment of 75% or less). In addition, NBFCs (engaged in non-fund-based activities) will no longer be restricted from setting up another subsidiary for undertaking another activity or from investing in another company engaged in financial services activity, which will provide greater operational freedom to such companies in their business structuring.
Despite the above positives, some regulatory uncertainty remains. Foreign investment in any “financial services activity” that is unregulated or partly regulated or where there is a regulatory oversight falls under the approval route. However, whether an activity is regulated can be decided only after determining if such activity concerns financial services. In the absence of any guidelines on the scope of financial services, the difficulty that may arise, as is evident from the applications made to the FIPB in the past, is the regulatory uncertainty as to whether a particular service will be construed as a financial services activity.
A glimpse at the list of 18 activities suggests that the government intended to include not only traditional financial services but also services supplementary and incidental to them, thus widening the scope of financial services. Inference can also be drawn from the broad definition of “financial services” in the Indian Financial Code Bill, 2014 (a law proposed for regulating the financial sector), which includes buying, selling, subscribing to financial products; safeguarding, managing, and administering financial assets; advisory services; data processing; making arrangements for carrying on any financial services; etc. In light of its wide connotation and in the absence of a clear guidance, it remains to be seen whether the regulatory confusion that existed before the change will continue to dampen investor confidence.
Additionally, under the approval route, the government may prescribe conditions (including minimum capitalization requirements) while granting approvals. After the elimination of such norms, the minimum capitalization requirements that a potential investor under the approval route would need to meet will become known only once the approval for the investment is granted, by which time the commercial terms may have already been frozen.
To conclude, the government has liberalized the financial sector with the view to increasing FDI inflow. The changes made to the policy are in the right direction and will bring cheer to the sector. However, the impact on investor sentiment of the regulatory uncertainties explained above is not yet known.
Luthra & Luthra is a full-service law firm with a pan-India presence. Dipti Lavya Swain is a partner and Prateek Rastogi is a managing associate. The views expressed here are personal. They are intended for general information purposes and are not a substitute for legal advice.