Foreign Direct Investment (FDI) Foreign Direct Investment (FDI) & & Foreign Institutional Investment (FII) Foreign Institutional Investment (FII)

Foreign Direct Investment (FDI) Foreign Direct Investment (FDI) & & Foreign Institutional Investment (FII) Foreign Institutional Investment (FII)

A Presentation by:

Kedar Gharat 20 Manoj Gupta 21Pramod Jadhav 24Ashish Lalpuria 34Arun Pacheco 38Nilesh Raut 49Anand Singh 60Sachin D’souza 63

2

Road Map for Presentation

What is FDI & FII

FII Guidelines

Distinction between FDI & FII

Case Studies

FDI Guidelines

Background

3

Background: India Transformed !!India Transformed !!

India -- the largest Democracy - one of the fastest growing economies in the World!

Slow rate of growth

Bureaucratic

Protected and slow

Small consumer markets

Weak infrastructure

…Yesterday

…Today

Strong macro economic fundamentals

Encouraging foreign investment

Outsourcing destination

Growing consumerism

Impetus on infrastructure development

ADVANTAGES INDIA HAS TO OFFER

• Stable democratic environment over 60 years of independence

• Large and growing market

• World class scientific, technical and managerial manpower

• Cost-effective and skilled labour

• Abundance of natural resources

• Large English speaking population

• Well-established legal system with independent judiciary

• Developed banking system and vibrant capital market

• Well developed accountancy, legal, actuarial and consultancy profession

4

5

What is FDI & FII

Foreign Direct Investment (FDI):

1. FDI stands for Foreign Direct Investment, a component of a country's national financial accounts.

2. Foreign direct investment is investment of foreign assets into domestic structures, equipment, and organizations.

3. It does not include foreign investment into the stock markets.

4. FDI is thought to be more useful to a country than investments in the equity of its companies because equity investments are potentially "hot money" which can leave at the first sign of trouble, whereas FDI is durable and generally useful whether things go well or badly.

Foreign Institutional Investment (FII):

1. FII denotes all those investors or investment companies that are not located within the territory of the country in which they are investing.

2. “SEBI’s definition of FIIs presently includes foreign pension funds, mutual funds, charitable/endowment/university funds etc. as well as asset management companies and other money managers operating on their behalf.”

6

Distinction between FDI and FII

FDI

1. It is long-term investment

2. Investment in physical assets

3. Aim is to increase enterprise capacity or productivity or change management control

4. Leads to technology transfer, access to markets and management inputs

5. FDI flows into the primary market

6. Entry and exit is relatively difficult

7. FDI is eligible for profits of the company

8. Does not tend be speculative

9. Direct impact on employment of labour and wages

10.Abiding interest in mgt.

FII

1. It is generally short-term investment

2. Investment in financial assets

3. Aim is to increase capital availability

4. FII results in only capital inflows

5. FII flows into the secondary market

6. Entry and exist is relatively easy

7. FII is eligible for capital gain

8. Tends to be speculative

9. No direct impact on employment of labour and wages

10.Fleeting interest in mgt. 6

7

Overview

8

Foreign Direct Investment Policy…

• Foreign Direct Investment (‘FDI’) – cross border investment with an objective to establish ‘lasting interest’

• Objective - to encourage FDI to promote industrial & socio-economic development; supplement domestic capital/ technology

• Foreign investment in India is regulated by Government of India’s FDI policy. The FDI guidelines administered by the Ministry of Commerce and Industry.

• Department of Industrial Policy & Promotion (‘DIPP’), Foreign Investment Promotion Board (‘FIPB’) and Secretariat of Industrial Assistance (‘SIA’) regulate the FDI Policy

• GoI has set up the Foreign Investment Implementation Authority (FIIA) to facilitate quick translation of Foreign Direct Investment (FDI) approvals into implementation, to provide a one-window to foreign investors by helping them obtain necessary approvals, sort out operational problems and meet with various Government agencies

• Administrative and compliance aspects of FDI monitored by RBI

• Since 1991, policy has been liberalized substantially to facilitate foreign investment

9

Foreign Direct Investment Snapshot

5549

15730

2457927309

22963

0

5000

10000

15000

20000

25000

30000

2005-06 2006-07 2007-08 2008-09 2009-10* * April 2009 – January 2010

184%

56%

Figures in

Million US$

• Mauritius, Singapore and Cyprus are the favorite jurisdictions for investment into India

• Foreign investment (‘FI’) from Mauritius constituting 43%* of India’s total FI

*as per information in the Press

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India's Hottest FDI Destinations

1. Maharashtra

Maharashtra received the lion's share of the FDI $2.43 billion (Rs 11,154 crore), which is 35% of the total FDI inflows in to the country,.

2. National Capital Region

NCR received $1.85 billion (Rs 8,476 crore) in FDI during the period. The region accounted for 20% of the total FDI.

3. West Bengal, Sikkim, Andaman & Nicobar Islands

These states attracted the third highest FDI inflows worth $1.416 billion (Rs 6,050 crore)

4. Karnataka - $936 million (Rs 4,333 crore)

5. Punjab, Haryana, Himachal Pradesh - $904 million (Rs 4,141 crore)

Data: Jan – Jun 2010

11

The Roadmap so far…

Allowed selectively up to 40%

Up to 51% under ‘Automatic

Route’ for 35 Priority Sectors

Up to 74/51/50% in 111 Sectors under

‘Automatic Route’100% in some sectors

Up to 100% under ‘Automatic Route’ in

all sectors except a small negative list

Sectoral caps raised;Conditions relaxed;

Pre 1991 1991 1997 2000 Post 2000

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…Foreign Direct Investment Policy…

Only for cases other than Automatic Route and those mentioned in sectoral policy

Applies to cases with existing venture/ tie up in ‘same filed’

Applies to investment over 24% in SSI reserved items

Government Route

Allowed for Most sectors

Limits : Sectoral caps/ stipulated sector specific guidelines

Inward remittances through proper banking channels

Pricing valuations prescribed

Post facto filing with 30 days of fund receipt

Filings within 30 days of share allotment

Includes Technical Collaboration/ Brand Name/ Royalty

Automatic Route

FDI Guidelines for Investing in Indian Wholly Owned Subsidiary / Joint Venture

Foreign Investment Promotion Board (FIPB)

No Prior Regulatory Approval but only Post Facto Filings to RBI, through

AD

13

…Foreign Direct Investment Policy

Existing Airports

100%

Asset Reconstruction Companies

49%

Titanium Minerals

100%

Broadcasting (a)

Cigars & Cigarettes

100%

Courier

100%

Print Media (a)

26%

Single brand retailing

51%

Agriculture (b)

Atomic energy

Retail trading (except single brand up to 51%)

Lottery, betting and gambling

Chit fund, Nidhi company

Trading in Transferable Development Rights

Negative List

(Illustrative)

Prior Approval

(Illustrative)

NBFC (minimum capitalization norms)

IT / ITes

Financial services(a)

Telecom Sector (74% cap)(a)

Insurance (26 % cap)(a)

Real Estate(a)

Special Economic Zones

Infrastructure

Shipping

Manufacturing sector

Hotels and tourism

Automatic Route

(Illustrative)

Note: (a) Sector specific guidelines (b) Subject to certain exceptions

FDI limits – Illustrative list

14

Recent Developments

15

Setting the context…

• Contribution of FDI in India’s economic development is an acknowledged

fact.

• From inception policy subject to extensive amendments from time to time

through Press Notes, circulars and clarifications

• Press Note 2,3 and 4 of 2009 issued to provide clarity on indirect FDI and

downstream investment

• FM stressed the need for a consolidated FDI policy in Budget 2010-11

• Draft consolidated policy issued in late 2009 for public comments

• Consolidated FDI policy issued effective from 1 April, 2010

16

Consolidated FDI Policy – Salient Features

• Consolidated document of all foreign investment policies /regulations under FEMA, Press Notes, Press Releases and Clarifications issued by DIPP

• Underlying rationale to promote FDI through a policy framework that is transparent, predictable, simple and clear and which reduces regulatory burden

• As an investor friendly measure, a new Circular is proposed to be issued every six months

• Press Notes/Press Releases/Clarifications on FDI in force as of 31 March 2010 will stand rescinded. Savings for actions taken under earlier press notes

• Use of chapters, headings and definitions

• Two kinds of foreign investment – (i) FDI and (ii) Foreign Portfolio Investment (FPI)

FDI – strategic long term relationship and establish a lasting interest

FPI – no intention to influence the management of the investee entity

17

FDI Policy – Principles

• Capital defined as Equity, Compulsorily Fully Convertible Preference Shares and Compulsorily Fully Convertible Debentures

• Warrants, partly paid up shares other hybrid instruments not permitted for FDI

• Investment in other instruments such as:

− Non Convertible Preference Shares/ Debenture (‘NCP’) − Optionally Convertible Preference Shares/ Debentures (‘OCP’)− Partially Convertible Preference Shares/ Debentures (‘PCP’)

treated as External Commercial Borrowings (‘ECB’) - subject to ECB guidelines

• Existing NCP/ OCP/ PCP on cut off date outside sectoral cap till current maturity

18

FDI Policy – Principles …contd.

• FDI permitted in:

− Indian companies including micro & small enterprise − Partnership firm/ proprietorship concern – only by NRI/PIOs− Trust only in the form of VCFs

• Not permitted in LLPs or any other entities – under consideration

• Investment by FIIs permitted upto 10% for individual FII and 24% in aggregate

• Pricing of capital instruments (including conversion price for convertible instruments) is now required to be decided upfront at the time of issue of instruments

• Investment by FVCI in DVCF set up as trust would now require specific Government approval; FVCI can directly invest subject to FDI policy

19

Royalty/ Foreign Technology Agreement

Brand name/ trade mark royalty

• Payment of royalty upto 1% of domestic sales and 2% of exports permitted (without technology transfer)

• Where royalty for brand name/ trademark and technology, then overall limits of 5% of domestic sales and 8% of exports

All payments covered under

Automatic route, subject

to limits

Foreign Technology Agreements

• Lumpsum payments not to exceed USD 2 mn (per technology)

• Royalty upto 5% of domestic sales and 8% of exports

The Government has liberalized the aforesaid limits by permitting, under the automatic route, and without any restrictions:

− All payments for royalty− Lump sum fee for transfer of technology− Payments for use of trademark/ brand name

Earlier

Now

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Calculation of Indirect FDI…

Foreign Co.

I Co1

Overseas

India

I Co1

Overseas

India

I Co2

Foreign Co.

Direct FI

Indirect FI

Direct Foreign Investment Indirect Foreign Investment

21

Calculation of Indirect FDI…

Earlier

Different methods of computing Indirect FI prescribed for different sectors. E.g.- Telecom/ Broadcasting: Proportionate method

- Investing companies in Infrastructure/ Services sector: Management + Ownership Test

Foreign Co.

Co1

Overseas

India

Telecom sector

Co2

90%

60%

FI in Co2 is 54% (90*60%)

Co1*

Overseas

India

Infrastructure sector

Co2

49%

100%

FI in Co2 is NIL

Foreign Co.

*Management of Co1 with Indians

22

…Calculation of Indirect FDI*

Now

• Total FI is sum of Direct FI and Indirect FI

• FI to include all types of foreign investments

• For RIC own and control are cumulative conditions; for NRE these are non-cumulative

• The methodology to apply to every stage of investment at Indian company

Direct FI in Co2 = 39%Indirect FI in Co2 = NilTotal FI in Co2 = 39%

Non Resident Entity (‘NRE’)

Co1 (Owned and Controlled by RIC)

Co2 (Owned and Controlled by RIC)

Overseas

India40%

10%

39%

Direct FI in Co2 = 51%Indirect FI in Co2 = 49%Total FI in Co2 = 100%

NRE

Co1 (Owned or Controlled by NRE)

Co2 (Owned and Controlled by NRE)

Overseas

India51%

49%

51%

23

Downstream Investment…

Co1

Overseas

India

Co2

Foreign Co.

Downstream Investment

Co1 could be

- An investing company; or

- An investing-cum-operating company

Co2 is an operating company

24

Transfer of securities – basic rules

Type of transfer Window Key conditions

NR to NR or

NRI to NRIAutomatic Subject to prior venture/ tie up condition

R to NR Automatic- Min. valuation and compliances

- Activities not under approval route

NR to R Automatic Max. valuation and compliances

R to NR in financial services

RBI approval

--

Control or ownership from R to NR pursuant to M&A

Govt. approval

Only for sectors with sectoral caps

Gift by R to NRRBI approval

-Gift not to exceed 5% of paid-up capital

-Subject to sectoral caps

- Cap of USD 25,000 per calendar year

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Procedural Aspects

26

FDI Policy – Procedural Aspects

• Intimation of receipt of share application money – within 30 days

• Purpose of inward remittance clearly stated on FIRC

• Allotment of shares within 180 days of receipt of funds

• Funds against which shares not allotted to be refunded

• Reporting in Form FC GPR within 30 days of allotment

• In case of Approval route, application to FIPB along with supporting documents

• All applications to be placed before FIPB within 15 days

• FIPB empowered to prioritise applications based on sector, export potential etc.

• Violations of regulations attract penal provisions under FEMA

27

Sector Specific Guidelines

28

Sector Specific Guidelines Prohibited sectors

• FDI not allowed in the following:

− Retail trading (except single brand)

− Atomic Energy

− Lottery business

− Gambling & Betting

− Chit fund and Nidhi company

− Trading in Transferable Development Rights

− Real Estate business or construction of Farm Houses

− Sectors not opened for private sector investments

• Prohibition extended to foreign technology collaboration including licensing for franchisee, trademark, brand name or management contract for lottery, betting and gambling business

29

Sector Specific Guidelines Telecommunication

• FDI allowed in the following (illustrative):

− Basic and cellular

− Unified Access Services

− National/ International Long Distance

− Global Mobile Personal Communications Services (GMPCS)

− Other value added telecom services

• FDI in ISPs without gateways now capped at 74% in line with DoT guidelines of 2007

• Subject to guidelines issued DOT

• FDI Limits:

Automatic Route Approval Route

Upto 49% Upto 74%

30

Sector Specific Guidelines Private sector banks/ Civil Aviation

• No change in existing conditions

• FDI permitted under automatic route upto 49% and thereafter upto 74% under Approval Route

Banks

Civil Aviation

• No change in existing conditions

• FDI in Non-scheduled air transport services/ non-schedule airlines, Chartered and Cargo airlines permitted under automatic route upto 49% and thereafter upto 74% under Approval Route

31

Sector Specific Guidelines Broadcasting

• In the Broadcasting sector, all FDI are under the Approval route

• For reckoning the FDI limits, FII investment also to be considered

• Subject to guidelines issued by I&B ministry

• FDI permitted in broadcasting sector:

Activity Limit

Radio 20%

Cable Networks 49%

Direct to Home* 49%

Uplinking news/ current affair TV channel** 26%

Uplinking non news/ current affair TV channel 100%

* FDI component not to exceed 20%

** May be raised to 49% as per recent press reports

32

Sector Specific Guidelines Print Media

• FDI is permitted under Approval route based on nature of publication

• Investment subject to sectoral policy issued by Ministry of Information and Broadcasting

• FDI limits on publications:

Activity Limit

Newspapers/ periodicals dealing with news and current affairs*

26%

Scientific magazines/ specialty journals/ periodicals

100%

* May be raised to 49% as per recent press reports

33

INSURANCE

• FDI upto 26% allowed on the automatic route

• However, license from the IRDA has to be obtained & There is a proposal to increase this limit to 49%.

• FDI upto 100% is permitted under the automatic route for manufacture of drugs and pharmaceuticals (The following is the current position)

• i. FDI upto 74% in the case of bulk drugs, their intermediates Pharmaceuticals and formulations (except those produced by the use of recombinant DNA technology) would be covered under automatic route.

• ii. FDI above 74% for manufacture of bulk drugs will be considered on case to case basis.

• Foreign Investment up to 100% is allowed in green field projects under automatic route

• Foreign Direct Investment is allowed in existing projects

• - up to 74% under automatic route

• - beyond 74% and up to 100% subject to Government approval

DRUGS & PHARMACEUTICALS

AIRPORTS

INFRASTRUCTURE

100% FDI is permitted for the following activities:

Electricity Generation (except Atomic energy)

Electricity Transmission

Electricity Distribution

Mass Rapid Transport System

Roads & Highways

Toll Roads

Vehicular Bridges

Ports & Harbors

Hotel & Tourism

FDI in Investing companies in infrastructure/service sector (except telecom sector) will not be counted towards sectoral cap provided:

- Such investment is up to 49% &

- The management of the company is in Indian hands.

FDI in such companies will be through the FIPB route 34

FOREIGN INSTITUTIONAL INVESTORS

35

What are Foreign Investors looking for?

• Good projects

• Demand Potential

• Revenue Potential

• Stable Policy Environment/Political Commitment

• Optimal Risk Allocation Framework

•Rate of interest

•Speculation

•Profitability

•Costs of production

•Economic conditions

•Government policies

•Political factors

Factors affecting foreign investment

36

Foreign Institutional Investors

• FIIs can individually purchase upto 10% and collectively upto 24% of the paid-up share capital of an Indian company

• This limit of 24% can be increased to sectoral cap/ statutory limit applicable to the Indian company by passing a board resolution/shareholder resolution

• FIIs can purchase shares through open offers/private placement/stock exchange

• Shares purchased by FII through stock exchange cannot be sold through a private arrangement

• Proprietary funds, foreign individuals and foreign corporates can register as a sub- account and invest through the FII. Separate limits of 10% / 5% is available for the sub-accounts

• FIIs can raise money through participatory notes or offshore derivative instruments for investment in the underlying Indian securities

• FIIs in addition to investment under the FII route can invest under FDI route

37

Investment limits on Equity & Debt investments by FII

FII, on its own behalf, shall not invest in equity more than 10% of total issued capital of an Indian company.

Investment on behalf of each sub-account shall not exceed 10% of total issued capital of an India company.

For the sub-account registered under Foreign Companies/Individual category, the investment limit is fixed at 5% of issued capital.

These limits are within overall limit of 24% / 49 % / or the sectoral caps a prescribed by Government of India / Reserve Bank of India.

investment limits on debt investments by FII

For FII investments in Government debt, currently following

limits are applicable:

• 100 % Debt Route US $ 1.55 billion

• 70 : 30 Route US $ 200 million

• Total Limit  S $ 1.75 billion

For corporate debt the investment limit is fixed at US $ 500 million.

38

PARTICIPATORY NOTES

What is P-Note:

PNs are instruments issued by registered FIIs to overseas investors, who wish to invest in the Indian stock markets without registering themselves with SEBI.

Why is P-Note:

More than 30% of foreign institutional money coming into India is from hedge funds. Hedge funds, which thrive on arbitrage opportunities, rarely hold a stock for a long time.

P-Notes are issued to the real investors on the basis of stocks purchased by the FII.

To monitoring investments through P Notes, Sebi decided that FIIs must report P-Notes details.

Reporting by FIIs

P-Notes issued - 7th day of the following month.

The FII merely investing for themselves through P-Notes – Quarterly basis

FIIs who do not issue PNs but have trades – File 'Nil' undertaking on a quarterly basis.

39

Importance of FII Inflow - FM’s View October 26, 2010

• No controls on FII inflows

• RBI may check rupee appreciation

• The upward movement of the rupee against the dollar was sharp in recent weeks as the Indian currency has climbed about 5.6% since the beginning of September due to sustained capital inflows.

The FM believes that with FII inflows and forex reserves, the current account deficit should be contained at around 3% of the gross domestic product (GDP) (this fiscal).

The current account deficit is the gap between the amount the country pays to the external world against what it receives from abroad, barring capital movement. It was around 3.6% of GDP in the first quarter of 2010-11.

40

Advantages of FII

• Enhanced flows of equity capital

• FIIs have a greater appetite for equity than debt in their asset structure. It improve capital structures.

• Managing uncertainty and controlling risks.

• FII inflows help in financial innovation and development of hedging instruments.

• Improving capital markets.

• FIIs as professional bodies of asset managers and financial analysts enhance competition and efficiency of financial markets.

• Equity market development aids economic development.

• By increasing the availability of riskier long term capital for projects, and increasing firms’ incentives to provide more information about their operations, FIIs can help in the process of economic development.

• Improved corporate governance.

• FIIs constitute professional bodies, improve corporate governance.

41

Disadvantages of FII

• Problems of Inflation

• Problems for small investor

• Adverse impact on Exports

• Hot Money

42

FII Investments & Market Reaction

While strong inflow of funds from foreign institutional investors (FIIs)

has been a reason to cheer, it could turn into a nightmare and if the global investors make a sudden exit can send the bourses

crashing.

43

FII Inflows Vs Sensex

FII Investment from 2005 - 2010 BSE Sensex

FII Investment Vs Sensex FII average holding in BSE 500

44

45

Case Studies and Recommendations

UBS Fraud case

• - The funds held in the accounts of the two companies (ADAG Group )opened in UBS with the approval of RBI were transferred to another account without RBI’s approval, by obtaining overdrafts against cash collateral security provided through the funds.

• - Thereafter, substantial amounts were transferred to certain accounts belonging to 8-10 diamond dealers based in India and Belgium..

• - The funds were then passed on from the accounts of the diamond merchants to two funds that in turn invested them in the Indian stock market through FIIs.

• - Swiss bank UBS has been fined £8 million by UK's Financial Services Authority (FSA)

• - ED is probing the matter because the transactions may amount to violation of Indian foreign exchange and anti-money laundering laws.

The Prudential Assurance Company vs. DIT (Bombay High Court)

• - The Court has held that earnings of FIIs registered in India are in the nature of business income.

• - Such income is not taxable in India if the FII does not have a permanent establishment in India.

• - The judgement benefits FIIs investing in India from countries such as UK, USA.

• - Those from Mauritius that already enjoy capital gains tax exemption under a tax treaty India has with the island nation.

• - This is not likely to settle the debate over taxation of capital gains made by FIIs in India

• - Only a Supreme Court decision can provide a binding certainty on the issue. Th

Will the Vodafone case hit FDI?

• Case : Show cause notice to Vodafone was issued by Indian Revenue Authorities arguing that they had failed to discharge withholding tax obligation with respect to tax on gains made by Hutch on sale of shares to Vodafone

• The Bombay High court said Vodafone Group Plc is liable for an estimated $2.6 billion in taxes for its 2007 acquisition of one of India's largest mobile phone companies.

• Decision as well as the tax department’s approach creates tremendous uncertainty on what aspects of an offshore transaction may fall within the Indian tax net.

• Tax practitioners see inherent bottlenecks while computing tax liability on such deals.

• The Vodafone judgement will definitely impact foreign investments into India.

• This is bound to affect FDI/M&A/PE deals as companies would ascribe a higher tax weightage risk while entering India. Offshore deals may also start drying up.

• But due to growing image and future prospectus of country, we are developing as a prominent nation and FDI would get much strong over the years despite any such issues.

Recommendations for India

Do away with too many caps in the overall regulatory regime.

Increase FDI limit for Insurance Sector to 49% from current 26%.

Increase FDI limit for Retail Sector.

Allow FII 100% ownership

Easy access to Foreign Investor by simplifying the approval procedure and industrial license

Liberalize the locking period for FII & FDI

Allow FDI in investment companies

"Better Investment Climate" Need of the Hour.

Liberalise the economic policies further so as to overcome the fiscal deficits faced by Indian economy

Invite corporate giants from countries like USA, China and south Korea

Maintain a balance between domestic companies and foreign companies so as domestic companies could survive in front of foreign giants.

49

50

"If there is one place on the

face of this Earth where all

the dreams of living men have

found a home when man

began the dream of

existence, it is India".

Romain Rolland,

French philosopher