Doors opened to unregistered Foreign Investors

Pursuant to the Finance Minister’s 2011 budget speech, the Securities Exchange Board of India (SEBI) has issued a circular (dated August 9, 2011) allowing foreign investors, (including individuals) not registered with SEBI to invest in mutual fund schemes. In the wake of the US rating downgrade, SEBI’s timing seems opportune.

Unchartered Territory. This circular represents a radical shift in SEBI’s fundamental regulatory ethos of registering with SEBI. The onus has been shifted to the mutual funds (MF) to ensure that the Foreign investors [christened in this circular as Qualified Foreign Investors (QFIs)] are KYC compliant. Additionally, stringent obligations in the form of daily reporting obligations, i.e, on actual receipt and payment basis, have been imposed on the MF. The procedure and conditions for investing have been spelt out in considerable detail.

QFIs. QFIs have been explained to be a person resident in a country that is compliant with Financial Action Task Force (FATF) standards and that is a signatory to International Organization of Securities Commission\'s (IOSCO’s) Multilateral Memorandum of Understanding (MMoU). Further, QFI should not be a person resident in India and should not be registered with SEBI as Foreign Institutional Investor or Sub-account.

Direct Route. QFIs can invest through the direct route by holding the MF units in demat mode. QFIs shall be required to open a demat account with the Depositories Participant (DP) who has taken the approval from SEBI to commence the activity relating to MF subscription from QFIs. The redemption amount and the dividend payout shall be repatriable back into the same overseas bank account from which the subscription amount has been received. 

Indirect Route. The QFIs can also invest through indirect route by holding the MF units via Unit Confirmation Receipt (UCR). The MF shall be required to appoint one or more UCR issuer who shall be based overseas and one SEBI registered Custodian in India. The MF shall issue the rupee denominated units to the Custodian as an underlying security in demat mode against which the UCR issuer will issue UCR to the QFI. QFIs can subscribe or redeem only through the UCR issuer. The UCR issuer shall act as an agent of the MF. This process is quite similar to the existing mechanism for ADRs and GDRs.

Investment Ceiling. The aggregate investment by QFIs under both the aforementioned routes shall be subject to a overall ceiling of USD 10 billion for equity schemes and USD 3 billion in debt schemes. The investment by QFIs for debt schemes which invest in infrastructure debt of minimum residual maturity of 5 years, shall be subject to a total overall ceiling of US $3 billion within the existing ceiling of USD 25 billion for FII investment in corporate bonds issued by infrastructure companies. The last USD 2 billion under equity schemes and USD 0.5 billion shall be auctioned by the SEBI through bidding process.

Noteworthy Stipulations. (i) MF is required to ensure that QFIs can only subscribe or redeem MF units and that systematic Investments/ transfer/ withdrawals and switches are not available to the QFIs. (ii) MF/ DP shall ensure that the units held by QFIs by way of UCR/demat holding are non transferable and non tradable. (iii) MF/DP shall ensure that the units/UCR held by QFIs is free from all encumbrances. (iv) MF/ DP shall also ensure that the overseas bank account which QFIs has designated for the purpose is based in countries compliant with FATF standards and are signatory to MMOU of IOSCO. (v) MF shall ensure compliance with laws (rules and regulations) of the jurisdictions where the QFIs are based and also ensure that the interest of existing unit holders of the MF schemes are not adversely affected due to the issuance of UCRs/ demat units to the QFIs.

Whilst it appears that that SEBI has taken a progressive step by empowering even unregistered foreign investors to fund Indian markets, it is feared whether the onerous conditions imposed on the MF may act as a deterrent from accepting investments from many of the interested investors.  It remains to be seen whether this circular heralds a nightmare for the MF’s compliance team or a dream come true for the QFIs, and how much of this QFI investment accrues to the AUM of the mutual fund.