QFI route hopes for capital inflows

Author: | Published: 1 Aug 2012
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The qualified foreign investor (QFI) route allows foreign individual investors, pension funds and trusts to invest directly in Indian equities. Prior to its introduction, a foreign investor or trust could invest in India's equity markets through the foreign institutional investor (FII) route or via the non-resident Indian (NRI) route.

Despite the Government of India's (GOI's) initiative, investors have to-date not shown a strong response to the introduction of QFIs. Meanwhile, regulators have commented that more could be done to simplify the class of foreign investor coming to India, while clarification is also needed regarding the investing quota of QFIs, FIIs and FDIs.

QFIs include individuals, groups or associations, resident in a foreign country that is compliant with the Financial Action Task Force (FATF). This is an inter-governmental organization that sets standards and promotes effective implementation of legal, regulatory and operational measures for combating money laundering, terrorist financing and other related threats to the integrity of the international financial system. QFIs will also be signatories to the International Organisation of Securities Commission's (IOSCO's) multilateral memorandum of understanding. The FATF has 36 members consisting of 34 jurisdictions and two regional organisations. QFIs do not include FII/ sub-accounts.

The Reserve Bank of India grants general permission to QFIs for investment under the portfolio investment scheme (PIS) route similar to FIIs. QFIs can own up to 5% of Indian companies and their maximum cumulative investments can amount up to 10%. These limitations are over and above the FII and NRI investment ceilings prescribed under the portfolio investment route for foreign investment in India.

QFIs provide a more direct route than FIIs for foreign individuals or trusts to invest in the equity market. Previously, a foreign individual seeking to invest in Indian stocks had to be registered as a sub-account of an FII, which then applied to the Sebi on behalf of the sub-account holder. On the other hand, a QFI is allowed to invest through a Sebi-registered qualified depository participant (DP). The DP is responsible for ensuring that QFIs meet all 'know-your-customer' (KYC) requirements and other regulatory requirements. The new investment option is expected to attract more retail investors into the Indian market.

S&R Associates partner Juhi Singh says: "We see this as a very positive development for the equity market. As an option, the QFI route provides much less hassle for investors looking to enter the Indian market. Retail investors and hedge funds investors are now looking towards this new investment route."

One general counsel at an international investment bank, who wishes to remain anonymous, agrees. "Unlike FDI," he says, "the QFI route provides a more direct route for investing in the Indian market with less regulatory compliance requirements. It is also a lot easier to exit via QFI than via FDI. This should be highly attractive for investors who wish to invest in India on a short term basis."

External factors

However, some analysts have taken the view that this additional investment route will not boost the country's capital markets in the short term because of external market conditions. This is in spite of the fact that increasing capital inflows was one of the GOI's main reasons for introducing QFIs. They point to the fact that on January 2, the day following the introduction of QFIs, the Bombay Stock Exchange Sensitive Index (Sensex) rose just 0.4%.

QFIs were permitted to invest in mutual funds in August 2011.There were, however, no takers of this investment route because of market conditions. Sentiment among investors has been low because of the poor performing global financial markets and because of various retrospective tax amendments proposed in recent months by the GOI. In 2011, FIIs' net equity outflow was Rs 28.12 billion, compared to net equity inflow of Rs 13.33 billion in 2010 and Rs 83.42 billion in 2009.

India's equity market is still largely dependent on the investment atmosphere, and the country's GDP growth rate has been slowing down recently. Many investors worry that they may have already missed the boat when it comes to investing in this emerging market. Some analysts believe that the QFI investment route is unlikely to play a facilitating role in stimulating India's equity market despite its positive influence, from a structural point of view, in widening the market base.

Several companies, such as ICICI Bank, are already very near their foreign holdings ceiling, which may impact on QFI investment


Investors are also not responsive to the introduction of QFIs because of their unwillingness to obtain a permanent account number (PAN) card, which is required for utilising the QFI route. A PAN card is normally used for filing tax returns. Dividends from companies and mutual funds are not taxable in India, and so investors worry that if their profiles are exposed during the process of obtaining a PAN they might fall in the tax net in future.

Finally, the opportunity to invest in India's equity market is restrained by ceilings implemented on foreign holdings. There are presently several companies in India that have already reached their ceilings on foreign holdings. And the foreign holding proportions of HDFC Bank and ICICI Bank are near their ceilings.

On the regulatory side, some legal practitioners say that the QFI investment route fails to realise some of the earlier objectives of the GOI to simplify foreign investor classes in India. In a report dated July 30 2010 and submitted by the Working Group on Foreign Investment, it was suggested that the various foreign investment routes should merge into one. More specifically, FIIs, foreign venture capital investments (FVCIs) and NRIs should be abolished and replaced with a single class, namely QFIs, with a single set of governing norms. At the moment, however, the QFI route has been introduced as an additional investor class with differing governing norms. This further complicates the classes of investment.

Clarification is needed on whether the QFIs will affect the quota of FDI and FII to invest in various industry sectors. Tejesh Chitlangi, a senior associate at Finsec Law Advisors, says: "The conflict between the QFI regime vis-à-vis the FII and FDI regime may be dealt with and necessary changes prescribed. For instance, there are sectors wherein there are separate limits for FII and FDI prescribed under Indian exchange control norms. As QFI investments would be over and above FII investments, there will be a need to clearly provide if the QFIs will cut through the FDI quota or if FII participation in such sectors will be reduced."

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