Until recently, only two categories of non-resident investors, namely, (i) foreign institutional investors (FIIs) and their sub-accounts registered with the Securities and Exchange Board of India (SEBI), and (ii) non-resident Indians (NRIs), were permitted to purchase listed securities on the stock exchanges, under the “portfolio investment scheme” of the Reserve Bank of India (RBI), specified in the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000 (FEMA Regulations). Other foreign investors, including individual foreign nationals, were not permitted to purchase listed securities on the stock exchanges. To widen the class of investors and attract additional foreign funds, in January, the Indian government permitted “qualified foreign investors” (QFIs) to directly invest in the Indian capital markets.
QFIs are individuals, companies and other artificial juridical persons that are resident in a foreign country which is compliant with the Financial Action Task Force (FATF) standards (for countries not compliant with FATF standards, see www. fatf-gafi.org) and a signatory to the multilateral memorandum of understanding (MMoU) of the International Organization of Securities Commissions (IOSCO) (see www.iosco.org), and whose ultimate beneficial owner is not resident in India. SEBI-registered FIIs and their sub-accounts and foreign venture capital investors are excluded from the definition of QFIs.
QFIs are permitted to invest only in equity shares (and not in any other type of security, such as preference shares, debentures or warrants) of Indian companies in public or rights offerings or on a recognized stock exchange in India through SEBI-registered stockbrokers or pursuant to bonus issues, stock split or consolidation, or amalgamation, demerger or other corporate actions; sell equity shares through SEBI-registered stockbrokers or in an open offer under the SEBI takeover regulations or the SEBI delisting regulations or through buyback under the SEBI buyback regulations; and receive dividends.
QFIs are prohibited from issuing offshore derivative instruments or participatory notes against underlying equity shares listed or proposed to be listed on a recognized stock exchange in India, which, subject to certain conditions, FIIs are permitted to issue. Further, QFIs are not permitted to pledge or otherwise encumber the equity shares held by them.
Unlike FIIs, QFIs are not required to be registered with SEBI. QFIs are however required to hold equity shares in a dematerialized (demat) account opened with a SEBI-registered depository participant (DP). Each QFI can open only one demat account and, for purposes of the permitted transactions, must designate one overseas bank account based in a country which is compliant with the FATF standards and is a signatory to IOSCO’s MMoU and a separate rupee bank account with an authorized dealer bank in India. A QFI is also required to obtain a distinct “permanent account number” from the Indian income tax department.
The QFI regulations impose obligations on DPs (some of which appear to be cumbersome) for ensuring compliances by QFIs. For example, DPs must satisfy themselves that QFIs meet the prescribed “know your customer” requirements and therefore are required to carry out the necessary due diligence and obtain appropriate declarations and undertakings from QFIs.
DPs are also required to ensure that, at the time of opening the demat account and on an ongoing basis, QFIs comply with the prevention of money laundering laws of India, the FAFT standards, the applicable SEBI rules and regulations, and the laws, rules and regulations of the jurisdictions where QFIs are based.
Therefore, interaction with the DP is important to consider from a QFI’s perspective.
The individual and aggregate investment limits for QFIs are 5% and 10%, respectively, of the paid-up capital of the Indian-listed company. These limits are over and above the investment limits prescribed for FIIs and NRIs under the portfolio investment scheme. Investments by QFIs are also subject to the applicable sector limits specified under the Indian government’s foreign direct investment (FDI) policy.
The QFI regulations do not contemplate an increase beyond the 10% aggregate QFI limit. If the aggregate shareholding of QFIs exceeds 10%, the QFI due to which the limit is breached will be required to divest excess holdings within the specified time period. The QFIs, DPs and listed companies concerned are responsible for monitoring compliance with the limits.
The QFI regulations may lead to amendments to the FEMA Regulations, the FDI policy and the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009. The listing agreements with the stock exchanges may also need to be amended to disseminate QFI shareholding information.
Mohit Gogia and Brajendu Bhaskar are lawyers at S&R Associates, a law firm with offices in New Delhi and Mumbai. The above information is a general legal update and not a substitute for legal advice.
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