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

A Presentation by: Kedar Gharat Manoj Gupta Pramod Jadhav Ashish Lalpuria Arun Pacheco Nilesh Raut Anand Singh Sachin Dsouza 20 21 24 34 38 49 60 63

Road Map for Presentation

Background

What is FDI & FII

Distinction between FDI & FII

FDI Guidelines

FII Guidelines

Case Studies
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Background: India Transformed !!

Yesterday Slow rate of growth Bureaucratic Protected and slow Small consumer markets Weak infrastructure Today Strong macro economic fundamentals Encouraging foreign investment Outsourcing destination Growing consumerism

Impetus on infrastructure development

India -- the largest Democracy - one of the fastest growing economies in the World!
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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
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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. SEBIs 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.
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Distinction between FDI and FII

FDI FII 1. It is generally short-term investment 2. Investment in financial assets 3. Aim is to increase capital availability

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

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.
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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.

Overview

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 Indias 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
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Foreign Direct Investment Snapshot

30000 24579 25000 20000 15730
Figures in Million US$

27309 22963

15000 10000 5549 5000 0 2005-06 2006-07 2007-08 2008-09 2009-10*

* April 2009 January 2010

Mauritius, Singapore and Cyprus are the favorite jurisdictions for investment into India
Foreign investment (FI) from Mauritius constituting 43%* of Indias total FI
*as per information in the Press

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
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The Roadmap so far

Sectoral caps raised; Conditions relaxed;

Up to 100% under Automatic Route in all sectors except a small negative list

Up to 51% under Automatic Route for 35 Priority Sectors Allowed selectively up to 40%

Up to 74/51/50% in 111 Sectors under Automatic Route 100% in some sectors

Pre 1991

1991

1997

2000

Post 2000
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Foreign Direct Investment Policy

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

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

Foreign Investment Promotion Board (FIPB) 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

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Foreign Direct Investment Policy

FDI limits Illustrative list
Automatic Route (Illustrative) Prior Approval (Illustrative) Negative List (Illustrative)
100% 49% 100% 100% 100% 26% 51%

Note:

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

Existing Airports Asset Reconstruction Companies Titanium Minerals Broadcasting (a) Cigars & Cigarettes Courier Print Media (a) Single brand retailing

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

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

Recent Developments

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Setting the context

Contribution of FDI in Indias 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 downstream investment FM stressed the need for a consolidated Draft consolidated policy

provide clarity

on indirect FDI and

FDI policy in Budget 2010-11

issued in late 2009 for public comments

Consolidated FDI policy issued effective

from 1 April, 2010

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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

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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

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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

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Royalty/ Foreign Technology Agreement

Earlier
Brand name/ trade mark royalty Foreign Technology Agreements All payments covered under Automatic route, subject to limits

Payment Where

of royalty upto 1% of domestic sales and 2% of exports permitted (without technology transfer) royalty for brand name/ trademark and technology, then overall limits of 5% of domestic sales and 8% of exports

Lumpsum payments not to exceed

USD 2 mn (per technology)

Royalty upto 5% of domestic sales

and 8% of exports

Now 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
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Calculation of Indirect FDI

Direct Foreign Investment Indirect Foreign Investment

Foreign Co.
Overseas India

Foreign Co.
Overseas

Direct FI

India

I Co1

I Co1

Indirect FI
I Co2
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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

Telecom sector

Infrastructure sector
Overseas India

Foreign Co.
90%

Foreign Co.
Overseas

49%

India

Co1
60%

Co1*
100%

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

Co2
FI in Co2 is NIL

*Management of Co1 with Indians

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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
Non Resident Entity (NRE)
40% 39%
Overseas India

NRE
51%
51%

Overseas India

Co1 (Owned and Controlled by RIC)

10%

Co1 (Owned or Controlled by NRE)

49%

Co2 (Owned and Controlled by RIC) Direct FI in Co2 = 39% Indirect FI in Co2 = Nil Total FI in Co2 = 39%

Co2 (Owned and Controlled by NRE) Direct FI in Co2 = 51% Indirect FI in Co2 = 49% Total FI in Co2 = 100%
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Downstream Investment

Foreign Co. Co1 could be

Overseas India

- An investing company; or - An investing-cum-operating

company
Co2 is an operating company

Co1

Downstream Investment
Co2

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Transfer of securities basic rules

Type of transfer NR to NR or Automatic NRI to NRI - Min. valuation and compliances R to NR Automatic - Activities not under approval route Subject to prior venture/ tie up condition Window Key conditions

NR to R
R to NR services in

Automatic
financial RBI approval

Max. valuation and compliances

--

Control or ownership Govt. from R to NR pursuant to approval M&A

Only for sectors with sectoral caps -Gift not to exceed 5% of paid-up capital

Gift by R to NR

RBI approval

-Subject to sectoral caps - Cap of USD 25,000 per calendar year

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Procedural Aspects

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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

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Sector Specific Guidelines

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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

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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 Upto 49%

Approval Route Upto 74%

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Sector Specific Guidelines Private sector banks/ Civil Aviation

Banks

No change in existing conditions FDI permitted under automatic route upto 49% and thereafter upto 74% under Approval Route

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

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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 20% 49%

Radio Cable Networks

Direct to Home*
Uplinking news/ current affair TV channel** Uplinking non news/ current affair TV channel
* FDI component not to exceed 20% ** May be raised to 49% as per recent press reports

49%
26% 100%

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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 26% 100%

Newspapers/ periodicals dealing with news and current affairs* Scientific magazines/ specialty journals/ periodicals
* May be raised to 49% as per recent press reports

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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%.

DRUGS & PHARMACEUTICALS

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.

AIRPORTS

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
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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
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FOREIGN INSTITUTIONAL INVESTORS

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What are Foreign Investors looking for?

Factors affecting foreign investment Rate of interest Speculation

Good projects
Demand Potential Revenue Potential Stable Policy Environment/Political Commitment Optimal Risk Allocation Framework

Profitability
Costs of production Economic conditions Government policies Political factors
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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 arrangement stock exchange cannot be sold through a private

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

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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 70 : 30 Route Total Limit US $ 1.55 billion US $ 200 million S $ 1.75 billion
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For corporate debt the investment limit is fixed at US $ 500 million.

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.
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Importance of FII Inflow - FMs 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.

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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.

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Disadvantages of FII

Problems of Inflation
Problems for small investor

Adverse impact on Exports

Hot Money

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FII Investments & Market Reaction

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

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

cheer

crashing.

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FII Inflows Vs Sensex

FII Investment from 2005 - 2010
120000 100000 80000 60000 40000 20000 0 -20000 -40000 -60000 -80000 2005 2006 2007 2008 2009 2010 Rs. in (Crores)

BSE Sensex

Rs. in (Crores)

FII Investment Vs Sensex

FII average holding in BSE 500

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Case Studies and Recommendations

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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 RBIs 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 departments 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.
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"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

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