Portfolio Investment by Foreign Institutional Investors
(Page: 4 of 4)

A country with a developing economy cannot depend exclusively on its own domestic savings to propel its economy's rapid growth. The domestic savings of India presently are 25% of its GDP. But this can provide only a 2 to 3% growth of its economy on annual basis. The country has to maintain an 8 to 10% growth for a period of two decades to reach the level of advanced nations and to wipe out widespread poverty of its people. The gap is to be covered by inflow of foreign investment along with advanced technology.

As per the Development Goals and Strategy of the 10th Plan, which is currently under implementation:

"The strategy to achieve a high annual growth target of 8.00% combines accelerated capital accumulation to raise the average investment rate from 24.23% to 28.41% with an increase in capital-use efficiency to reduce the ratio of incremental capital to output from 4.00 to about 3.55. Private sector development, infrastructure development, and increased foreign investment and trade are key to increasing efficiency"

The regular inflow of external capital investment is indispensable to sustain our economic growth at the planned level and this is well recognised by the plan document itself.

When remittances are made by Foreign Institutional Investors for portfolio investments, such remittances are on trading account, as securities can be bought, as well as sold back through approved stock exchanges. This may be trading transaction, but net amount at any time (purchases minus sales) is a significant figure and this adds to the foreign exchange reserves of the country

The term Foreign Institutional Investor is defined by SEBI as under:

"Means an institution established or incorporated outside India which proposes to make investment in India in securities. Provided that a domestic asset management company or domestic portfolio manager who manages funds raised or collected or brought from outside India for investment in India on behalf of a sub-account, shall be deemed to be a Foreign Institutional Investor."

Liberal Tax Concessions are offered to the FIIs to attract them to invest in Indian Securities Market. The taxation of income of Foreign Institutional Investors from securities or capital gains arising from their transfer for the present, shall be as under: -

• The income received in respect of securities (other than units of offshore funds covered by section 115 AB of the Income-Tax Act) is to be taxed at the rate of 20%.

• Income by way of long-term capital gains arising from the transfer of the said securities is to be taxed at the rate of 10%.

• Income by way of short-term capital gains arising from the transfer of the said securities is to be taxed at the rate of 30%.

The rates of income tax as aforesaid will apply on the gross income specified above without allowing for any deduction under sections 28 to 44-C, 57 and chapter VI-A of the Income-Tax Act. The expression "securities" referred to above shall have the meaning assigned to it in clause (h) of section 2 of the Securities Contract (Regulation) Act, 1956. These include Shares, Scrips, stocks, bonds, debentures, debenture stocks or other marketable securities of a like nature in or of any incorporated or other body corporate; Government securities; and Rights or interests in securities

On this new path of liberalisation of the Indian economy, portfolio investments by Foreign Institutional Investors (FIIs) in primary or secondary markets are allowed subject to a ceiling of 24 per cent of issued share capital for the total holdings of all registered FIIs in any one company. The ceiling would apply to all holdings taking into account the conversions out of the fully or partly convertible debentures issued by the company. Also the holding of a single FII in any company would also be subject to a ceiling of 5 per cent of total issued capital. For this purpose, the holding of an FII group will be counted as single FII. Further the maximum holding of 24 per cent for all nonresident FIIs will also include NRI and OCB investments but will not include Offshore Single Regional Funds, Global Depository Receipts and Euro Convertible Bonds.

The most important feature of the guidelines issued by the Finance Ministry, Government of India is that there will be no restriction on the volume of investments of FIIs and no lock-in period prescribed for the purposes of such investments made by FIIs.

Category -1:The applicant should belong to any of the following categories:

• Pension Funds

• Mutual Funds

• Investment Trust

• Insurance or reinsurance companies

• Endowment Funds

• University Funds

• Foundations or Charitable Trusts or Charitable Societies who propose to invest on their own behalf.

Category -2: FIIs who propose to invest their proprietary funds or on behalf of "broad based" funds or on of foreign corporates and individuals.

• Asset Management Companies

• Nominee Companies

• Institutional Portfolio Managers

• Trustees

• Power of Attorney Holders

• Bank

Investment by FIIs is regulated under SEBI (FII) Regulations, 1995 and Regulation 5(2) of FEMA Notification No.20 dated May 3, 2000. SEBI acts as the nodal point in the entire process of FII registration. FIIs are required to apply to SEBI in a common application form in duplicate. A copy of the application form is sent by SEBI to RBI along with their 'No Objection' so as to enable RBI to grant necessary permission under FEMA. RBI approval under FEMA enables an FII to buy/sell securities on stock exchanges and open foreign currency and Indian Rupee accounts with a designated bank branch. FIIs are required to allocate their investment between equity and debt instruments in the ratio of 70:30. However, it is also possible for an FII to declare itself a 100% debt FII in which case it can make its entire investment in debt instruments. FIIs can invest in listed and unlisted securities including shares, debt instruments dated Government Securities and Treasury Bills. No individual FII/sub-account can acquire more than 10% of the paid up capital of an Indian company. All FIIs and their sub-accounts taken together cannot acquire more than 24% of the paid up capital of an Indian Company. Indian Companies can raise the above mentioned 24% ceiling to the Sectoral Cap / Statutory Ceiling as applicable by passing a resolution by its Board of Directors followed by passing a Special Resolution to that effect by its General Body in terms of Press Release dated Sept.20, 2001 and FEMA Notification No.45 dated Sept. 20,2001. Presence of Sectoral Cap/ Statutory ceiling means that foreign investment from all sources cannot exceed a specified level. A Company to which no sectoral cap/statutory ceiling is applicable can raise the limit of permissible FII investment to 100% of the paid up capital. A Company to which a 49% cap is applicable can raise the limit of permissible FII investment to 49% and if there is an existing foreign direct investment of 15%, possible FII investment can only be up to 34%.

No permission from RBI is needed so long as the FIIs purchase and sell on recognized stock exchange. All non-stock exchange sales/purchases require RBI permission. In order to ensure that the sectoral / statutory ceilings on foreign investment in a company are not violated due to investment by FIIs, RBI monitors these ceilings for the companies in respect of which sectoral caps /statutory ceiling have been indicated by Government of India.

When the total holdings of FIIs reaches within 2% of the applicable limit, Reserve Bank issues a notice to all concerned that any further purchases of the shares of the said Company requires prior approval of RBI. FIIs can avail of the Forward Cover Facility from the Authorized Dealer subject to certain conditions. High Net worth Individuals /foreign corporates can invest through SEBI Registered FIIs subject to a sub-limit of 5% each within the aggregated limit of 24%. Registered Foreign Institutional Investors (FIIs) are allowed to trade in all exchange traded derivative contracts approved by SEBI from time to time subject to the limits prescribed by SEBI.

As per Regulation 6 of SEBI (Foreign Institutional Investors) Regulations, 1995, Foreign Institutional Investors are required to fulfill the following conditions to qualify for grant of registration:

• Applicant should have track record, professional competence, financial soundness, experience, general reputation of fairness and integrity;

• The applicant should be regulated by an appropriate foreign regulatory authority in the same capacity/category where registration is sought from SEBI. Registration with authorities, which are responsible for incorporation, is not adequate to qualify as Foreign Institutional Investor.

• The applicant is required to have the permission under the provisions of the Foreign Exchange Management Act, 1999 from the Reserve Bank of India.

• Applicant must be legally permitted to invest in securities outside the country or its in-corporation / establishment.

• The applicant must be a "fit and proper" person.

• The applicant has to appoint a local custodian and enter into an agreement with the custodian. Besides it also has to appoint a designated bank to route its transactions.

• Effect Payment of registration fee of US $ 5,000.00.

Various terms used in the above are defined as under:

Designated Bank
means any bank in India, which has been authorised by the Reserve Bank of India to act as a banker to Foreign Institutional Investors.

Domestic Asset Management Company
means an asset management company approved by the Board under the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996 and who has been granted certificate of registration under Securities and Exchange Board of India (Portfolio Managers) Regulations, 1993.

Domestic Custodian
includes any person carrying on the activity of providing custodial services in respect of securities.

Domestic Portfolio Manager
means a portfolio manager registered under the Securities and Exchange Board of India (Portfolio Managers) Regulations, 1993.

Sub-account
includes foreign corporates or foreign individuals and those institutions, established or incorporated outside India and those funds, or portfolios, established outside India, whether incorporated or not, on whose behalf investments are proposed to be made in India by a Foreign Institutional Investor.

The methodology of investing pattern by Mutual Funds and the portfolio investments by FIIs are live examples of portfolio managers operating in the field and brings added clarity to the concept explained earlier in abstract terms. As we know what a portfolio manager does, it is next necessary to know how he does it. This is discussed in the next two modules.