- Joseph Pookkatt and Awantika Manohar

Indian residents are generally not permitted to invest in the foreign securities market; however, in recent years, a phased liberalisation policy for outward capital flows has seen resident Indians remitting close to $1bn abroad. The Reserve Bank of India's latest data shows that despite the financial turmoil overseas, remittances by resident Indians under the Liberalised Remittance Scheme touched $983m in financial year 2010, up from $808m in FY09.

This robust growth of investments in foreign securities is happening despite the fact that India has exchange control restrictions, due to the absence of full capital account convertibility. The rising Indian investments abroad are today an indication of India's participation in the process of globalization and of the new-found global economic ambitions of many resident Indian investors.

Regulatory regime

Indian residents are generally not permitted to invest in foreign securities, except as according to the regulations that are framed under the Foreign Exchange Management Act, 1999 or as prescribed by the RBI through a specific or general permission. Only banking companies licensed in India can solicit foreign currency deposits from residents or act as agents for overseas mutual funds or any other foreign financial services company. Mutual fund regulations, however, do not restrict entry of any foreign asset manager into India.

Foreign asset management companies are subject to foreign investment guidelines which the Foreign Investment Promotion Board prescribes. Under the present guidelines issued by the FIPB for foreign investment into India, asset management activity is part of the definition of non-banking finance activity. Certain minimum capitalisation norms have been laid down for foreign investment in such non-banking finance companies. In the light of the high capitalisation requirements, several of the international players like Prudential, Alliance, Sun F&C, Fidelity and Franklin Templeton have elected to enter the market via joint ventures with a domestic partner. Investment in this sector is under the automatic route, whereby no prior approval of the FIPB would be required for setting up the AMC.

The regulation of mutual funds that operate in India falls under the purview of the authority of the Securities and Exchange Board of India. Any person who proposes to set up a mutual fund in India is required, under the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, to be registered with the SEBI.

Offshore mutual funds that may not want to set up operations in India but are interested in participating in Indian capital markets have done so by investing through a scheme of an existing domestic mutual fund. SEBI approval of the overseas fund and the domestic scheme is largely based on the fulfilment of several criteria, including whether the overseas fund is a broad-based fund and that approval of the RBI and the Ministry of Finance under Section 115AB of the Income Tax Act, 1961 has been obtained. There are no hedge funds domiciled in India and they are not allowed to raise funds from the domestic market. SEBI, by not granting FII status to any applicant that described itself as a hedge fund, has essentially barred foreign hedge funds from directly participating in the Indian public equity markets.

Marketing offshore funds to resident Indians

India does not have any regulatory regime for the direct marketing by foreign fund managers of offshore funds in India. Under a scheme that the RBI has announced, all resident individuals are allowed to freely remit up to $200,000 per financial year (April–March) for any permissible current or capital account transaction or a combination of both and subsumes investment by resident individual in overseas companies. Such remittances can be made in any freely convertible foreign currency equivalent to $200,000 in a financial year.

As indicated above, only authorised bankers can solicit foreign currency deposits from residents. All banks, both Indian and foreign, including those that do not have an operational presence in India, have to seek prior approval from the RBI for the schemes being marketed by them in India to residents, either for soliciting foreign currency deposits for their foreign/overseas branches or for acting as agents foroverseas mutual funds or any other foreign financial services company. Based on the background of the transaction and terms of the offering, the RBI may grant approval subject to applicability of certain conditions with which the Indian or foreign bank must comply.

Marketing by Indian mutual funds

SEBI has permitted Indian mutual funds to make investments in foreign debt securities. As per a circular that SEBI issued, mutual funds have been allowed to invest in foreign debt securities with highest credit rating (such as A-1/AAA by Standard and Poor's, P-1/AAA by Moody's, F1/AAA by Fitch IBCA, etc.) in the countries with fully convertible currencies, provided the guidelines laid down in the circular are complied with. Similarly, Indian mutual funds have also been permitted to make investments in non-Indian government securities where the countries are AAA rated. Such investment is permitted subject to an overall cap of $7bn per mutual fund for making investments in the Foreign Debt Securities and American Depository Receipts/Global Depository Receipts issued by Indian companies.

Prospectus

In India, the prospectus may have to comply with elaborate disclosure requirements that are comparable to a public issue, which may at times be difficult to comply with and impractical. In the absence of any specific directions from SEBI or the Department of Company Affairs, effort should be made to limit general solicitation, i.e., the offer should be limited to less than 50 persons.

Restrictive legend

A legend should be affixed to each offering memorandum that is circulated in India which provides all the restrictions applicable under the foreign exchange regulations in India.

Compulsory certification of sales/marketing personnel

To educate sales personnel on the current regulations and to ensure that no false representations are made to the investors, SEBI, together with the Association of Mutual Funds of India, has made it mandatory for the sales and marketing personnel of mutual funds to obtain a certification. This requires such personnel, prior to certification, to appear for a test which is currently conducted by the National Institute of Securities Markets. This is a significant move towards bringing in more accountability to the asset management company.

Using the internet

The web sites of mutual funds/asset management companies have to provide updated information about their fund. Contract notes with digital signature are valid, subject to obtaining a certificate from the certifying authority under the Information Technology Act, 2000. SEBI prescribes minimum requirements for internet-based purchases and sales of units.