Fiis - Regulations and Impact on India

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FIIs – Regulations and Impact on Indian Markets

Who is a Foreign Institutional Investor?

A foreign Institutional Investor (FII) is an institution established or incorporated outside India which proposes to make investment in securities of companies incorporated in India (“Indian Companies”) [1]. FIIs seeking to invest in Indian Companies are required to be registered with the Securities and Exchange Board of India (SEBI). They need to comply with the provisions of the Guidelines for Foreign Institutional Investors and the Securities and Exchange Board of India (Foreign Institutional Investors) Regulations, 1995 (the "SEBI Regulations").

The majority of the foreign investment into the securities market in India comes from Mauritius, a member of International Organisation of Securities Commissions (IOSCO), because of the existence of a favourable tax treaty between the two countries [2]. Nearly 30% of the FIIs trading on the Indian stock market operate from Mauritius. As on June 27, 2008 the number of FIIs registered with the SEBI was 1403.

Regulation of FIIs

There are two main bodies regulating portfolio investment in India- SEBI and RBI (Reserve Bank of India). Every FII is required to register with SEBI and shall comply with the Exchange Control Regulations of RBI. SEBI (FII) Regulations, 1995 and Regulation 5(2) of FEMA regulates the FIIs. Under the regulation of FEMA, RBI approval is also required in order to purchase or sell securities on stock exchanges, open foreign currency and Indian Rupee accounts with a designated bank branch. The permission from RBI is not required so long as the FIIs purchase and sell on

recognized stock exchange. All non-stock exchange sales/purchases require RBI permission.

Registration with the SEBI

a) Major Criterias

FIIs seeking a license from the SEBI are required to be registered with a recognized foreign securities regulatory authority (recognized by the SEBI) or foreign tax authority. •They must have a five-year track record of good performance.

If the SEBI is satisfied that the applicant has complied with all the requirements, it will issue its “in-principle” approval.

Investment Channels through FIIs

FIIs invest their own funds or on behalf of their sub-accounts/clients. Currently no separate registration fee is payable by sub-accounts. An entity already registered as a sub-account of an FII registered with the SEBI cannot be registered as a sub-account of another FII registered with the SEBI. Some of these clients invest through Participatory Notes (PNs).

PNs are offshore derivative instruments that allow foreign investors to invest in the country’s stock markets without disclosing their identity i.e. PNs are market instruments that are created and traded overseas. Hence, the Government of India cannot ban or control the issue of PNs; they can only regulate them. Participatory Notes, somewhere down the line, hide in themselves the functions and properties of Hedge Funds. Although SEBI, as a regulator had issued KYC (Know Your Client) guidelines, which

include that, FIIs must know all the requisites details about their client and should be able to furnish the details of the same, as and when demanded or asked by the regulator, to which there should be strict compliance.

Investment Restrictions on FIIs

FIIs are allowed to invest in the primary and secondary capital markets in India through the portfolio investment scheme (PIS). Under this scheme, FIIs can acquire shares/debentures of Indian companies through the stock exchanges in India.

FIIs registered with the SEBI can invest up to 30% of their own corpus in debt securities of Indian Companies. Therefore, Regular FIIs follow what has come to be known as the “70:30 rule”, i.e. they must invest no less than 70% of their funds in equity-related instruments and may invest the remainder in debt-related instruments. They can also invest in unlisted securities of...
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