The Securities and Exchange Board of India (SEBI), through a circular dated 13 January, allowed qualified foreign investors (QFIs) to invest in the Indian equity market. The decision to open the equity market to this class of investors had been announced by the Ministry of Finance in a press release dated 1 January.
The circular extends the permitted investment areas for QFIs from investment in mutual fund schemes and bonds for infrastructure (introduced by SEBI on 9 August 2011), to investments directly in listed Indian companies on the floor of the stock exchange, public issues, rights issues, etc. QFIs are now also allowed to tender equity shares in open offers pursuant to takeovers or delisting, and to tender equity shares in a buyback.
A QFI is non-resident “person” who resides in a country that is compliant with Financial Action Task Force (FATF) standards and is a signatory to the International Organization of Securities Commissions’ Multilateral Memorandum of Understanding, provided that such person is not registered with SEBI as a foreign institutional investor (FII) or its sub-account.
“Person” is defined widely, as in section 2(31) of the Income Tax Act, 1961, to include an individual, a Hindu undivided family, a company, firm, association or any other legal person. FATF is an inter-governmental body that fosters the development and promotion of national and international policies to combat money laundering and terrorist financing.
SEBI requires that settlement of market trades in listed securities take place in dematerialized (demat), or electronic, form. A QFI is required to and can open only one demat account with a SEBI-registered qualified depository participant (QDP) by complying with the know-your-customer (KYC) norms.
Prior to the circular, the only means by which a non-resident could make direct investments in a listed company in India was through the portfolio investment scheme (PIS). FIIs registered with SEBI, their sub-accounts and non-resident Indians (NRIs) are entitled to invest through the PIS route.
The QFI route allows a wide range of foreign investors to invest in the Indian equity market with less stringent conditions than those imposed on FIIs and their sub-accounts. However, entities whose ultimate beneficial ownership cannot be determined, or entities having opaque ownership structures, will not be able to meet the KYC norms and consequently cannot invest in the Indian markets through the QFI route.
New limits and scope
QFIs are allowed to invest up to 5% individually and up to 10% in aggregate of the paid-up capital of an Indian listed company. While these limits are over and above the FII and NRI investment ceilings prescribed under the PIS for foreign investment in India, there may be a conflict in sectors where there are separate investment limits for FII and foreign direct investment.
While FIIs and their sub-accounts are specifically excluded from investment through the QFI route, the circular is silent on whether NRIs can invest through this route.
The stringent conditions imposed on FIIs and their sub-accounts under the SEBI FII Regulations, 1995, makes it difficult for some entities to meet the eligibility and ongoing requirements set out in the regulations. This dissuades some entities from using this investment route. While the QFI regime would open new investment opportunities for foreign investors, QDPs will need to be strict about KYC norms to ensure than an unregulated class of investors does not bring more volatility, rather than more stability, to the Indian markets, defeating the whole purpose of allowing the new class of investors.
It will be interesting to see the effect that the QFI route will have on the FII/sub-account route as investors might choose KYC norms set by QDPs over the restrictions under the regulatory framework applicable to SEBI-registered FIIs and their sub-accounts.
Some observers suggest that the QFI route may not prove suitable for retail investors who are unfamiliar with Indian stocks. Such people might be wise to invest through offshore funds dedicated to the Indian markets rather than hold their own portfolios.
While the QFI route would allow a wide gamut of foreign investors to directly tap the Indian equity market, we may have to wait to see the extent to which it will help Indian companies raise funds in the current market conditions. Consistent with the recent approach, it will be interesting to see whether the Ministry of Finance and SEBI consider opening the doors of the Indian debt market to direct investment by QFIs as well.
Chirayu Chandani is an associate at Khaitan & Co. Khaitan & Co is a full-service law firm with offices in Mumbai, Delhi, Bangalore and Kolkata. Views expressed in the article are those of the author and do not necessarily reflect the views of the firm.
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