The Indian securities regulators scheme aimed at
foreign trades was a key step in liberalising the
countrys capital markets, explains Ajay Vaidya, chief
legal and compliance officer of Kotak Mahindra
To understand India's capital markets, you must know how the
rules have developed over the years: the timeline of government
notifications can extend back to even the 1950s. However, until
India started liberalising in 1992, it was a very closed
Once liberalisation began, there was great demand for
foreign money to enter the stock market. However, Indian
promoters were worried that foreign investors with enormous
amounts of capital would take over and destabilise their
In 1995 the Securities and Exchange Board of India (Sebi)
established the Foreign Institutional Investor (FII) scheme.
This primarily allowed the entrance of portfolio investors such
as mutual funds, pension funds, sovereign funds,
asset-management companies and their managed funds that aimed
to be traders rather than strategic investors.
When the FII rules were announced in 1995, FII holdings in a
company were capped at five percent. At present, one FII can
have 10% of outstanding capital in a company and altogether
FIIs can hold 24%. If FIIs want to increase their shareholdings
in a company past 24%, the company is able to pass a
shareholder resolution allowing them to do so, up to
permissible foreign investment limits.
The FII route has also developed the participatory Notes (P
Notes) investment route, where regulated investors get indirect
access to the Indian stock market. Under this route, a FII
first buys the security, and then swaps its returns with the P
Note buyer. FIIs are also big investors in Indian IPOs. With
the opening of Indian markets to new products, FII now have
significant investments in exchange traded derivatives, mutual
funds, and debt securities.
When speaking with FIIs, I often ask about their management
style. In India, domestic investors have not been activists,
but FIIs vote with their feet. If a company isn't run well
if it doesn't deliver on its promises or if it isn't run
efficiently investors will sell their shares.
This has resulted in the improvement of corporate governance
standards. Some FIIs have been very active in engaging with
companies about their expectations, which helps retail
investors by enhancing minority shareholder rights.
Now FIIs are very influential. When Sebi makes regulations,
it realises that retail investors piggyback on FII investment.
For example, FIIs cannot withdraw their bids on IPOs; as when
retail investors see a large number of FIIs in a book, they
come in. If FIIs suddenly withdraw, it is seen as harmful for
the retail investors.
In the last 17 years, FIIs have been very helpful for
expanding India's markets. The government recognises their
input, and has even added one more category for foreign
investors: the qualified institutional buyer.
For more of IFLR's 30th anniversary coverage
Liberalisation of Indian foreign investment policy
India welcomes new foreign investment rules
India FDI reforms explained
Efforts to attract