Qualified Foreign Investors

Fundamentals: Qualified Foreign Investors (QFIs)

From the first week of January 2012, the Qualified Foreign Investors (QFIs) are allowed to Directly Invest in Indian Equity Market. The idea is to widen the class of investors, attract more foreign funds, and reduce market volatility and to deepen the Indian capital market. We take this opportunity to understand the fundamentals of this concept.

What are Qualified Foreign Investors (QFIs)?

This term is made up of three words viz. Qualified + Foreign + Investors. The emphasis is on Qualified. In the countries such as India, where financial markets are not fully liberalized, an investor authorised / recognized by the local financial regulator such as SEBI or RBI in India, to participate in certain types of transaction as long as specific criteria are met are called Qualified Foreign Investors (QFIs).

The investment by QFIs or any other entity in a country depends upon:

» Local regulations

» Investment schemes or markets involved

If the QFI is an Institutional investor such as hedge funds, insurance companies, pension funds and mutual funds, which are registered out of India would be called QFII that is Qualified Foreign Institutional Investors.

Was there a complete NO to QFIs in India before this?

No. Please note that in India, QFIs have been already permitted to have direct access to Indian Mutual Funds schemes pursuant to the Budget announcement 2011-12. The latest decision seems to be a next logical step in the direction. So far, there has been a complete no to QFIs in equity markets.

What was the position as of now?

In the present arrangement relating to foreign portfolio investments, only Foreign Institutional Investors or FIIs/sub-accounts and NRIs are allowed to directly invest in Indian equity market. In this arrangement, a large number of Qualified Foreign Investors (QFIs), in particular, a large set of diversified individual foreign nationals who are desirous of investing in Indian equity market do not have direct access to Indian equity market. In the absence of availability of direct route, many QFIs find difficulties in investing in Indian equity market.

How it would help?

There are two major dimensions of this policy measure:

» The policy decision is aimed to increase the depth of the Indian Market, and widen the range of investors

» It is also aimed at Combating Volatility Beside Increasing Foreign Inflows into the County

The above two dimensions would attract more foreign funds and reduce market volatility. Experts believe the move will benefit the market in the long term, but its impact will be minimal in the coming months. The short term impacts may not be seen because poor risk appetite among global investors is likely to keep most foreign individuals away from entering the Indian stock market in the next few months.

But when the Government previously allowed QFI’s to invest in Mutual Funds, was it successful?

The government’s earlier step allowing foreign retail investors direct access to Indian mutual fund schemes has not been successful so far. In August, Sebi had issued detailed guidelines to allow QFIs direct entry in equity and debt schemes of domestic mutual fund houses. However, the move has not taken off, due to stringent know-your-client norms such as mandatory permanent account number and tax filing details.

Are QFIS a separate class of foreign investors compared to FIIs?

» Qualified Foreign Investors will be distinct from foreign portfolio investors and NRIs.

» A QFI can, for instance, be a foreign individual investor in Singapore or Russia, who can buy into stocks of a Tata group company or Coal India or any other listed stock after fulfilling the Know Your Customer norms through an Indian depository participant and obtaining the approval of the RBI.

» QFIs can buy up to 5% of the paid-up capital of a company, with the overall limit capped at 10% in a company. And these investment limits are separate or over and above that for FIIs and NRIs.

What are salient features of the scheme?

RBI would grant general permission to QFIs for investment under Portfolio Investment Scheme (PIS) route similar to FIIs. The individual and aggregate investment limit for QFIs shall be 5% and 10% respectively of the paid up capital of Indian company. These limits shall be over and above the FII and NRI investment ceilings prescribed under the PIS route for foreign investment in India.

» QFIs shall be allowed to invest through SEBI registered Qualified Depository Participant (DP). A QFI shall open only one demat account and a trading account with any of the qualified DP. The QFI shall make purchase and sale of equities through that DP only.

» DP shall ensure that QFIs meet all KYC and other regulatory requirements, as per the relevant regulations issued by SEBI from time to time. QFIs shall remit money through normal banking channel in any permitted currency (freely convertible) directly to the single rupee pool bank account of the DP maintained with a designated AD category – I bank. Upon receipt of instructions from QFI, DP shall carry out the transactions (purchase/sale of equity).

» DP shall be responsible for deduction of applicable tax at source out of the redemption proceeds before making redemption payments to QFIs.

» Risk management, margins and taxation on such trades by QFIs may be on lines similar to the facility available to the other investors.

What are the key implications?

» This move leads to further dis-intermediation of the capital markets for foreign investors who were earlier forced to come through the FII route.

» Depending on the eligibility criteria that may be prescribed for QFIs, this could potentially have a knock-on effect on FII and sub-account eligibility criteria leading to easing of the norms for such registrations.

» It needs to be seen how the limits are monitored for entities who may also come in under the QFI route.

» This easier access to Indian stocks could further bring more transparency in terms of beneficial owner as against the offshore derivative instruments which have always attracted the ire of the regulators for their perceived lack of transparency.

» It needs to be seen if this route which is now open only for equity securities would be extended to listed debt and derivative instruments as well in future.

Important Points:

» Qualified Foreign Investors (QFIs) include individuals, groups or associations resident in a country compliant with anti-money laundering forums

» Move expected to attract more foreign funds, reduce market volatility, and deepen Indian capital market

» Comes at a time when FIIs have been pulling out of India

» QFIs will have to open demat and trading account with qualified depository participant. All deals will have to be through this route

» Detailed norms expected to be issued by Sebi over next 2 weeks QFIs need to meet KYC norms

Conclusion

Considering the grim state of capital markets across the globe generally, the introduction of the proposed QFI route would forecast well for the Government to stimulate investment activity. While the issuance of Press Release is a proactive step by the Government to address the changing need of the times, only upon release of the fine print of the regulatory framework governing QFIs, one would be able to determine whether the QFI route would provide greater attraction to foreign investors as compared to the extant investment regimes. Therefore, it’s now for the regulators to draft QFI regulatory framework in line with the intent of the Government. Imposition of any onerous conditions or restrictions would simply cause to add the QFI route to the already existing FII/sub-account and the NRI investments routes without providing boost to foreign inflows.