Some issues surrounding FII investments in India

By Rajat Sethi and Radhika Iyer, S&R Associates

Indian regulations have generally recognized that the objectives of foreign direct investment (FDI) are different from “portfolio investment”; in the latter case, investors do not expect to influence the management of an enterprise. Consistent with this rationale, foreign corporations, funds or individuals that meet the criteria for a foreign institutional investor (FII) or a sub-account, and that register with the Securities and Exchange Board of India (SEBI), are allowed to invest in securities of an Indian company under the portfolio investment scheme (PIS), subject to certain specified ceilings.

India opened the doors to FIIs under the PIS in 1992. Since then, the rules and regulations governing such investments in India have evolved to keep up with changing requirements. Yet, there is lack of clarity on certain basic issues surrounding such investments.

Unlisted companies

The SEBI (Foreign Institutional Investors) Regulations, 1995, as amended (SEBI regulations), set out the framework for investment by FIIs in Indian companies. In addition, the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations, 2000, as amended (FEMA regulations), recognize that FIIs may invest in securities of Indian companies under the PIS (which is distinct from the FDI scheme under the FEMA regulations).

Rajat Sethi Partner S&R Associates
Rajat Sethi
S&R Associates

The SEBI regulations, as amended in 1996, permit FIIs to invest in securities in the primary and secondary markets, including shares, debentures and warrants of companies unlisted, listed or to be listed on a recognized stock exchange in India, subject to certain investment limits.

However, under the FEMA regulations, in relation to investments under the PIS, FIIs are required to purchase shares through a registered broker on a recognized stock exchange in India. This has been construed to mean that an FII may not invest in securities of an unlisted Indian company under the PIS. One view is that any investment by an FII in an unlisted Indian company should be treated as investment under the FDI scheme.

Therefore, there has been doubt as to whether FIIs are permitted to invest in unlisted Indian companies under the PIS.

Investment limits

An FII cannot hold more than 10% of the total paid-up equity capital of an Indian company and the total holding of all FIIs in an Indian company cannot exceed 24% of such a company’s paid-up equity capital. Separately, FII investments are also subject to the sectoral caps for foreign investment prescribed in the FDI policy issued by the government of India.

An Indian company can increase the total investment limit of 24% by FIIs up to the prescribed sectoral cap for foreign investment by a special resolution, agreed by a three-fourths majority of the shareholders present and voting at a general meeting.

The FDI policy recognizes the distinction between FDI and portfolio investments; however the treatment of portfolio investments is unclear. Sectoral caps are described in different ways, for example:

(a) The sectoral cap for most sectors is described as an FDI cap, however, investment by FIIs through the PIS is not specifically addressed;

(b) The sectoral cap for some sectors, such as asset reconstruction companies, is described as an FDI cap and investment by FIIs is specifically prohibited; and

(c) The sectoral cap for some sectors, such as private banking and print media, specifically includes investment by FIIs, while the sectoral cap for other sectors provides a composite cap with separate FDI and FII sub-limits.

Radhika Iyer Associate S&R Associates
Radhika Iyer
S&R Associates

This chaotic arrangement of sectoral caps for FDI and portfolio investments has led to considerable uncertainty among investors.

In the past, at least two committees constituted by the government of India (the Lahiri Committee in June 2004 and the Working Group on Foreign Investment in July 2010) have dealt with this issue in detail. The Lahiri Committee Report on Liberalization of Foreign Institutional Investment recommended that FII investment ceilings, if any, should be reckoned over and above prescribed FDI sectoral caps.

Likewise, the Report of the Working Group on Foreign Investment recommended that the existing structure for foreign investments in India be revamped and that investor categories such as FIIs, foreign venture capital investors and non-resident Indians be abolished. The report recommended that there be two classes – FDI and qualified foreign investors (QFIs) – and, in the absence of separate ceilings imposed by legislation, the investment limits for QFIs should be over and above the sectoral caps for FDI.

Over the past year, SEBI and the Reserve Bank of India have introduced QFIs as a category of investors. However, it remains to be seen how soon the other issues surrounding portfolio investments in India are clarified by the regulators.

Rajat Sethi is a partner and Radhika Iyer is an associate at S&R Associates, a law firm based in New Delhi and Mumbai. They can be contacted at and


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