In this article, Nubee Naved who is currently pursuing Diploma in Entrepreneurship Administration and Business Law from NUJS, Kolkata, discusses Who is a foreign institutional investor?
Foreign Institutional Investor
Foreign Investments are imperative for the growth of any developing country. These are investments usually made by the resident of a country in the financial assets and production process of a different country. Such investments are considered highly imperative to boost the development of any economy i.e. infrastructure, labor etc. Another important aspect of foreign investment is that it allows a country to meet its trade deficits by building up its foreign exchange reserves.
It often creates a financial channel through which various important sectors of a country’s economy for e.g. I.T, agriculture etc. gain access to foreign capital and positively affects the factor productivity and balance of payments of the country in its entirety. Foreign investment is usually done through foreign direct investment (FDI) and through foreign institutional investment (FII).
FDI is a long-medium term investment and comprises of direct production activities whereas foreign institutional investment is usually a short term investment involves different markets like foreign exchange markets, money markets and stock markets. According to the Securities and Exchange Board of India (Foreign Institutional Investors) Regulations, 1995, a “Foreign Institutional Investor” means an institution established or incorporated outside India which proposes to make investment in India in securities.
A Historical Background
Foreign Institutional Investments are pivotal for a developing economy like India as they contribute immensely to the inflow of capital funds due to insufficiency of funds multilateral financial institutions. It is to be noted that India’s development strategy focused primarily on import substitution and self-reliance until the 1980’s. Debt flows and official development assistance were two important resources which financed current account deficits. It would be logical to say that there was in fact a general inclination towards private commercial flows and foreign investment. India’s policy reforms had materially changed since the commencement of the whole economic reforms process in the early 1980’s and during the initiation of the liberalization era in the early 1990’s, India managed to draw a lot of attention from foreign investor which ultimately culminated in a rise of foreign institutional investments in India. FII was permitted in 1992 with reasonable restrictions as a result of the recommendation of the Narsimhan Committee Report on Financial System. The Committee did not extensively elaborate on the aims and objectives of the Financial Policy but emphasized on the need of opening up the domestic financial markets to foreign portfolio investments. Foreign Institutional Investors were permitted to invest in all the securities traded on the primary and secondary markets, which primarily consisted of debentures, shares and warrants issued by companies which were listed or were to be listed on the Stock Exchanges in India. The then Finance Minister of India, while presenting the budget for the financial year 1992-93 proposed a motion to allow various reputed investors to invest in the Indian Capital Market for e.g. Pension Funds etc.
Governing Foreign Institutional Investors
There are certain entities which are eligible to invest in the Indian capital markets under the FII route. These entities can invest in the markets as FII or as sub-accounts and are divided as follows:
- Investment trust, mutual funds, asset management company, nominee company, overseas pension funds bank, institutional portfolio manager, university funds, endowments, charitable trusts, foundations, charitable societies, a trustee or power of attorney holder incorporated or established outside India intending to make proprietary investments are all examples of investments which can be termed as foreign institutional investments.
- Sub Account: The sub-account is generally the underlying fund on whose behalf the FII invests. The entities which are eligible to be registered as sub-accounts, viz. private company, public company, partnership firms, pension fund, investment trust, and individuals.
A Foreign Institutional Investor is required to get itself registered and for this purpose it is required to obtain a certificate from SEBI for dealing in securities. The certificate is granted by SEBI after it has taken into account the following criteria[1]:
- The track record of the applicant which includes the its track record, financial soundness, competence, experience, general reputation of integrity and fairness
- Whether the applicant has been granted permission to make foreign investments in India as a Foreign Institutional Investor under the provision of the Foreign Exchange Regulation Act, 1973 by the Reserve Bank of India.
- Whether the applicant is regulated by a foreign regulated authority
- Whether the applicant is a fit and proper person
- Whether the certificate granted to the applicant is in the interest of the growth of the securities market
- Whether the applicant is:
- an International or Multilateral Organization or an agency thereof or a Foreign Governmental Agency or a Foreign Central Bank or;
- An institution incorporated or established outside India as a mutual fund, investment trust, pension fund, insurance company or reinsurance company or;
- An investment manager or asset management company or advisor, nominee company, bank or institutional portfolio manager, established or incorporated outside India and intending to make investments in India on behalf of broad based funds and its proprietary funds in if any or;
- University fund, endowments, foundations or charitable trusts or charitable societies.[2]
Conditions and Restrictions with regard to Investments
There are certain conditions and restrictions placed on the investments done by FII. Investors are allowed to invest only in the following:
- Securities in both primary and secondary markets encompassing debentures, shares and warrants of companies, listed, unlisted or to be listed on a stock exchange recognized in India
- Units of schemes floated by domestic mutual funds including Unit Trust of India, whether listed or not listed on a recognized stock exchange.
- Security receipts
- Commercial Paper
- Securities dated by the Government
- Derivatives traded on a recognized stock exchange.
While granting approval for the investments, SEBI may set certain conditions which may be necessary with respect to the maximum amount which can be invested in the debt securities by an FII on its own account or through its sub-accounts. A hundred percent investment through the debt route cannot be made by a foreign corporate or individual. Investments made in security receipts issued by asset reconstruction companies or securitization companies under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 by Foreign Institutional Investors shall also be deemed as ineligible. No foreign institutional investor is allowed to invest in security receipts on behalf of its sub-account.
Prohibitions on FII
An FII looking to invest in equity in equity issued by an Asset Reconstruction Company cannot do so as it is not permitted under the SEBI Rules, 1995. A FII is also to invest in any company which is engaged or proposes to engage in the following activities:
- Agricultural activities
- Nidhi Company
- Business of chit fund
- Trading in Transferable Development Rights
- Construction of Business
- Real Estate Business
Salient Features of FII
- FIIs including mutual funds, pension funds, investment trust, banks, asset management companies, Nominee Company, incorporated/institutional portfolio manager or their power of attorney holder (providing discretionary and non-discretionary portfolio management services) would be welcomed to make investments under the new guidelines. Investment in all securities traded on the primary and secondary markets including the equity and other securities/instruments of companies which are listed/to be listed on the stock exchanges in India including the OTC exchange of India is permitted.[3]
- A foreign institutional investor is required to obtain permission of initial registration with SEBI in order to enter the market nominee companies, An FII having any affiliated or subsidiary companies shall have to seek a separate registration with SEBI as such subsidiary companies are usually treated distinctly.
- An FII shall have to seek various permissions under Foreign Exchange Regulation Act, 1973 from the Reserve Bank of India because of the existence of foreign exchange controls in force. The registration shall be done under the single window approach.
- FIIs who wish to make an initial registration with SEBI are required to hold a registration from the requisite securities commission or any other regulatory authority for the stock market in their domicile or country of operation.
- SEBI’s initial registration shall hold for five years along with the RBI’s general permission under FERA, 1973 which will also be valid for five years and both shall be renewable for similar five periods in the future.
- The FIIs shall be able to sell, buy and realize capital gains on investments on investments made through the original corpus transferred to India under the FERA permission. It may also subscribe or renounce rights offering of shares, invest on all recognized stock exchanges through a designated bank branch and would be able to appoint a domestic custodian for the custody of the investment.[4]
- There would be no limitations on the volume of investment be it maximum or minimum for the purpose of entry of FIIs in the primary or secondary markets and also on the lock in period outlined for the objective of such investments made by FIIs.
References
[1] Foreign Institutional Investors in India: An Overview, SHODHGANGA, Available at http://shodhganga.inflibnet.ac.in/bitstream/10603/11266/10/10_chapter%202.pdf
[2] Ibid
[3] Supra, see note 1
[4]Supra, see note 1
