Easing restrictions for foreign portfolio investors
New SEBI regulations such as reducing investor categories are intended to make it easier for FPIs to invest in India’s domestic fund market
10 Jan 2020 | Hilton Yip
To improve this situation, the Securities and Exchange Board of India (SEBI) unveiled several regulatory changes in September to make investing in India easier for foreign investors. These include streamlining the categorical classification of foreign portfolio investors (FPI), allowing FPIs to buy or sell shares off-market, and further specifying know your customer (KYC) requirements. This will improve the future prospects of foreign investment in local funds in India, according to a panel discussion at The Asset’s Enhancing Access to India’s Investment Markets event in association with Standard Chartered Bank, which also highlighted several positive developments in the domestic market.
FPIs are non-resident investors in Indian securities including shares, bonds, and convertible securities, with their investment not exceeding 10 percent of the capital in the company. SEBI’s regulatory changes in September, one of the major changes in the last five years, reflected a serious intent to make improvements and simplify processes for foreign investors.
“There are over 9,000 FPIs registered in India from 59 countries,” says Chaitanya Joshi, executive director, head, securities services business, India, Standard Chartered Bank. “There have been ups and downs in flows. This has been one of the best years in overall FPI flows in recent years, at least in the middle months before seeing a dip in July and August.”
Total cumulative FPI investment for the year is at 1.10 trillion rupees (US$160 billion) as of the end of October, though the third quarter saw net outflows of 22.9 billion rupees.
The three FPI categories have now been consolidated to two. Category 1 includes sovereigns, regulated funds, dealers, and funds from FATF [Financial Action Task Force] countries like the US and
the UK. Cayman funds with a US or a UK manager will also be considered category 1. “That’s a big change because for category 1, the KYC and documentation are simpler as they are considered low risk,” explains Rajesh Gandhi, senior partner, Deloitte Haskins & Sells. “Category 3 will now be category 2. So, family office, corporates, funds from non-FATF countries etc become category 2. Compared to earlier category 3 KYC requirements, the requirements will also be lower in category 2.”
“Despite some complaints that the market is not deep enough or of the difficulty in accessing the market, a lot of progress has happened,” says Arbind Maheswari, managing director – head of India equities sales trading, DSP Merrill Lynch. “The kind of participation and the kind of investors participating have broadened tremendously over the last few years.”
AIFs [alternative investment funds] are a new category, and within FPIs, high-frequency trading never existed until a few years ago. And until recently, hedge funds were not considered an acceptable investment participant, but now many are getting licenses and actively trading. “Right from the retail investors to professional traders, there is a wide range and category of investors. The hope is you will continue to see more investors coming in,” adds Arbind.
Chaitanya notes that another access restriction was broad-based funds. “Before we had to explain to foreign investors what broad-based meant. Regulators listened to us, [so we have] moved from a number-based to risk-based country, jurisdiction comfort-based,” he says.
Previously, central banks could only come in if they were part of the BIS group. Now that has been relaxed so more central banks and countries can participate. SEBI is also looking at changes to allow even private banks to raise money and bring that into India.
Then there is the VRR (voluntary retention route) – a successful scheme that has helped to increase market depth of FPI investments into corporate assets.
“If you commit money for a certain period [under the VVR route], you’re exempt from a lot of the monitoring limits [debt limits] applicable to normal FPI. A lot of our clients, whether foreign banks, brokers or funds, are looking to take advantage of that,” adds Chaitanya.
Devesh Kumar, managing director, country head, CIMB Securities India, thinks that next year, when the new base is set, there’ll be a lot of inflows due to the large volume of interest. “People are coming to India but not putting their money in a way that you want,” he says.
Devesh also agreed that the domestic market has seen a lot of improvements such as increasing in size and number of domestic buyers. The domestic asset management industry has only emerged in the last six to seven years, according to Devesh.
“If you look at the size of mutual funds, it was tiny. One large international fund wants to exit but can’t exit because the price will get affected. That was keeping a lot of people away from the stock market. In the last four to five years, when international investors wanted to exit, they could exit because domestics were buying,” explains Devesh. “As the domestic fund industry grows, this will provide international investors with counterparties to trade.”
Ravi Varanasi, chief business development officer, National Stock Exchange of India, explains that in the past, India was a retail-dominated market, but the number of investors participating in securities and lending has significantly increased in the last couple of months. “Even today, non-proprietary money contributes almost 50% of the market. That’s a strength of the market. That possibly gives some comfort to international investors as well as local institutional investors,” he says.
Besides the growing number of investors, the range of investor products has also increased, and the variety of products available appeals to both highly risk-averse and sophisticated investors. “Most international investors are in the top 1,100 stocks. People are going into small and medium-cap stocks. That’s a fairly encouraging sign. We think product diversity will increase,” says Ravi.
However, the market is still lacking a lot of foreign investors, for now. Devesh explains that only
a small number of investors has entered so far, but the feeling is that there is a huge number of investors waiting outside and that it will prove tough to meet expectations and service them once they do enter.
The panelists also highlighted Gujarat International Finance Tec-City (GIFT City), a new development that will be India’s first smart city and international financial services centre. Any fund set up in GIFT City will become an FPI though existing restrictions will continue.
“Regulations say that any fund set up in GIFT City will automatically become an FPI and a regulated entity. India is a FATF country so it becomes a regulated entity from a FATF member. This will open some doors for funds set up in GIFT City to do onshore trading such as P [participatory] notes,” says Rajesh.
An arrangement has been struck with Singapore Exchange (SGX) enabling India-related futures contract products offered on SGX to be executed in GIFT City. As such, SGX will set up a subsidiary in GIFT City which will be a trading and clearing member of GIFT City exchange.
The National Stock Exchange is looking at the possibility of providing access to India products in GIFT City through a connect with the Singapore stock exchange and has received regulatory guidance from MAS [Monetary Authority of Singapore] and SEBI. It will be an omnibus structure that is allowed to set up in GIFT City. SGX will set up a special purpose vehicle in GIFT City to act as the conduit and would allow its members to pass through that with investor details maintained by SGX brokers.
“The GIFT City can be an experimental stage to test some of these ideas. If they work, some of them can be imported onshore,” concludes Ravi. 
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