The minority stakes in Indian corporations, which has been purchased by many offshore funds by mean of the foreign direct investment (FDI) route, is currently facing an uncertainty after the capital markets regulator Securities and Exchange Board of India (SEBI) had put a 10% minimum ownership threshold in the direction of classifying equity holdings below that level as portfolio investments.
The alteration in classification through the Securities and Exchange Board of India (Sebi) shall now need the affected overseas funds as well as private equity corporations, which have already made such investments as FDI, towards compulsorily secure licenses as foreign portfolio investors (FPI). By means of obtaining such a license would increase their compliance as well as regulatory liability. However, FDI investments do not require any license.
Though estimations vary, market participants consider that nearly 10-15% of annual FDI inflows shall require reclassification under the latest rules that took effect in the late last month.
The central bank data had shown that in the Financial Year 2019, inflows by means of the FDI route amounted towards $62 billion.
Previously, the classification of an investment has been determined through the route by which the investment was completed. With the changes in rules, in case a foreign fund buys below 10% stake in a corporation, such an investment shall be considered as FPI irrespective of the route selected. On the other hand, in case the ownership of an FPI in a corporation crosses 10%, then such an investment shall be considered FDI.
It was also held that if the FPI license is obligatory for foreign funds owning below 10%, it can create more issues. As per the FPI regime, an entity is not permitted to hold unlisted shares, whereas a large portion of FDI investments are in the unlisted space.
The Reserve Bank of India, which controls the FDI, has also stated that classification is further a function of ownership threshold rather than the purchase route utilized to own the stock.
The RBI has stated in a note on its website that the FDI and FPI are agnostic from the viewpoint of the schedule under which investment was made. It was the percentage which outlines whether it is direct or portfolio investment.
Therefore, overseas private equity companies are presently being recommended to get an FPI license from SEBI in order to continue holding below 10% in local assets. Also, FPIs are subjected to higher disclosures, which include know-your-customer (KYC) documentation relating to a fund’s key management officials.
The FDI and FPI routes are utilized by foreign funds for companies’ different reasons. The investments made through the FDI route are mostly calculated in nature and intended for the long term. Many FDI investors also hold a place to give opinion and advice in the management of the investee corporation, which also includes board seats.
Whereas, portfolio investments are temporary in nature, with investors having the freedom to purchase or sell stock on the bourses. Furthermore, FPIs are permitted towards investing only in listed securities, while FDI investments could be made even in unlisted assets.
Conclusion
It can be said that the condition for foreign investors towards compulsorily register as FPIs if they invest below 10% in an Indian listed corporation seems to be an unintended outcome of the FPI vs. FDI classification. A clarification on this made by the RBI shall assist to provide certainty.
However, in order to make certain, experts consider some of the FPI investors, also, would be affected. SEBI has stated that if the holding of an FPI group goes beyond 10% of the total equity of a corporation, an FPI has to cut the extra stake within 5 working days, and if they fail to do so, it would lead towards the investment being classified as FDI.
Therefore, experts held that the way exchange control regulations are put, any new investment made in below 10% of listed equity of an Indian corporation shall be required to be executed through the FPI route.
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