UNIT 4

EXTERNAL PARTICIPANTS IN
SECURITIES MARKET
 WHO IS A FOREIGN INSTITUTIONAL INVESTOR (FII)?

• A foreign institutional investor (FII) is an investor or an institution investing fund in a

country outside of the one in which it is registered or headquartered. The term
foreign institutional investor is probably most commonly used in India, where it refers
to outside entities investing in the nation's financial markets.
• A foreign institutional investor is an investor in a financial market outside its official
home country.
• Foreign institutional investors can include pension funds, investment banks, hedge
funds, and mutual funds.
• Some countries place restrictions on the size of investments by foreign investors.
 WHAT CONSTITUTES FII’S?

• FIIs can include hedge funds, insurance companies, pension funds, investment banks,
and mutual funds. FIIs can be important sources of capital in developing economies,
yet many developing nations, such as India, have placed limits on the total value of
assets an FII can purchase and the number of equity shares it can buy, particularly in
a single company.
• This helps limit the influence of FIIs on individual companies and the nation's
financial markets, and the potential damage that might occur if FIIs can cause during
a crisis.
• The benefits of FIIs to countries are that FIIs bring in foreign capital, which boosts
the economy of a nation. This spurs growth and shores up foreign reserves. It also
helps the FIIs as it allows for greater diversity and exposure to foreign markets.
 INVESTMENT BANKS
• Two broadly recognized functions of investment banks include capital market intermediation and
trading, distinguishing investment banks from commercial banks, which accept deposits and make
loans. Investment banks are critical agents of capital formation and price setting. They help to
coordinate present and future consumption.
• Investment banks are large financial institutions providing capital financing and engaging in trading.
• They help companies go public and underwrite bond offerings.
• Investment banks help the broader financial markets and the economy by matching sellers and
investors.
• The banks make financial development more efficient and promote business growth, which in turn
helps the economy.
• In contemporary mixed economies, governments and large companies rely on investment banks to
raise funds. Investment banks match those selling securities with investors. This is known as "adding
liquidity" to a market. Investment banks work with commercial banks to help determine prevailing
market interest rates.
• Examples are J.P. Morgan Chase, Goldman Sachs, Bank of America and Barclays Bank
 HEDGE FUNDS
• A hedge fund is a limited partnership of private investors whose money is managed by professional fund
managers who use a wide range of strategies, which includes trading of non-traditional assets, to earn
above-average investment returns.
• Hedge fund investment is often considered a risky alternative investment choice and usually requires a
high minimum investment or net worth, often targeting wealthy clients.
• Hedge funds are actively managed alternative investments that commonly use risky investment
strategies.
• Hedge fund investment requires a high minimum investment or net worth from accredited investors.
• Hedge funds charge higher fees than conventional investment funds.
• Common hedge fund strategies depend on the fund manager and include equity, fixed-income, and
event-driven goals.
• Examples are Motilal Oswal's offshore hedge fund, Munoth Hedge Fund and IIFL Opportunities Fund etc…
 MUTUAL FUNDS
• A mutual fund is an investment option where money from many people is pooled together to buy a variety
of stocks, bonds, or other securities. This mix of investments is managed by a professional
money manager, providing individuals with a portfolio that is structured to match the investment
objectives stated in the fund's prospectus.
• By investing in a mutual fund, individuals gain access to a broad range of investments, which can help
reduce risk compared to investing in a single stock or bond. Investors earn returns based on the fund's
performance minus any fees or expenses charged. In this way, mutual funds can give small or individual
investors access to professionally managed portfolios of equities, bonds, and other asset classes.
• A mutual fund is a type of investment vehicle consisting of a portfolio of stocks, bonds, or other
securities.
• Mutual funds give small or individual investors access to diversified, professionally managed portfolios.
• Mutual funds are divided into several kinds of categories, representing the kinds of securities they invest
in, their investment objectives, and the type of returns they seek.
• Mutual funds charge annual fees, expense ratios, or commissions, which may affect their overall returns.
• Employer-sponsored retirement plans commonly invest in mutual funds.
• Examples are ICICI Prudential Focused Blue-chip Equity Fund, Aditya Birla Sun Life Small & Midcap Fund, Tata
Equity PE Fund, HDFC Monthly Income Plan – MTP, L&T Tax Advantage Fund
REGULATIONS ON INVESTING IN INDIAN COMPANIES

• FIIs are allowed to invest in India's primary and secondary capital markets only
through the country's portfolio investment scheme. This scheme allows FIIs to
purchase shares and debentures of Indian companies on the nation's public
exchanges.
• However, there are many regulations. For example, FIIs are generally limited to a
maximum investment of 24% of the paid-up capital of the Indian company receiving
the investment. However, FIIs can invest more than 24% if the investment is
approved by the company's board and a special resolution is passed. The ceiling on
FIIs' investments in Indian public-sector banks is only 20% of banks' paid-up capital.
• The Reserve Bank of India monitors compliance with these limits daily by
implementing cutoff points 2% below the maximum investment. This gives it a
chance to caution the Indian company receiving the investment before allowing the
final 2% to be purchased.
 CONDITIONS AND RESTRICTIONS
• Foreign Institutional Investors (FIIs), Non-Resident Indians (NRIs), and Persons of Indian Origin
(PIOs) are allowed to invest in the primary and secondary capital markets in India through the
portfolio investment scheme (PIS). Under this scheme, FIIs/NRIs can acquire shares/debentures of
Indian companies through the stock exchanges in India.
• The ceiling for overall investment for FIIs is 24 per cent of the paid up capital of the Indian company
and 10 per cent for NRIs/PIOs. The limit is 20 per cent of the paid up capital in the case of public
sector banks, including the State Bank of India.
• The ceiling of 24 per cent for FII investment can be raised up to sectoral cap/statutory ceiling, subject
to the approval of the board and the general body of the company passing a special resolution to that
effect. And the ceiling of 10 per cent for NRIs/PIOs can be raised to 24 per cent subject to the
approval of the general body of the company passing a resolution to that effect.
• The ceiling for FIIs is independent of the ceiling of 10/24 per cent for NRIs/PIOs.
• The equity shares and convertible debentures of the companies within the prescribed ceilings are
available for purchase under PIS subject to:
• the total purchase of all NRIs/PIOs both, on repatriation and non-repatriation basis, being within an
overall ceiling limit of (a) 24 per cent of the company's total paid up equity capital and (b) 24 per cent
of the total paid up value of each series of convertible debenture; and
• the investment made on repatriation basis by any single NRI/PIO in the equity shares and convertible
debentures not exceeding five per cent of the paid up equity capital of the company or five per cent
of the total paid up value of each series of convertible debentures issued by the company.
 KEY POINTS OF DIFFERENCE BETWEEN FII, FDI & FPI
• Foreign Institutional Investment (FII), Foreign Direct Investment (FDI), and Foreign Portfolio
Investment (FPI) are all forms of foreign investment, but they differ in terms of their nature,
purpose, and impact on the economy. Here are the key differences between them:

• Foreign Institutional Investment (FII):

• FIIs are institutional investors, such as mutual funds, hedge funds, pension funds, and insurance
companies, that invest in the financial markets of a country.
• FIIs primarily invest in securities like stocks, bonds, and other financial instruments for short to
medium-term returns.
• They do not acquire ownership stakes or control in the companies they invest in.
• FIIs can quickly move capital in and out of the market, which can lead to volatility in financial
markets, especially in emerging economies.
• The regulations governing FIIs are generally focused on monitoring and regulating their investments
in financial markets.
 KEY POINTS OF DIFFERENCE BETWEEN FII, FDI & FPI
• Foreign Institutional Investment (FII), Foreign Direct Investment (FDI), and Foreign Portfolio
Investment (FPI) are all forms of foreign investment, but they differ in terms of their nature,
purpose, and impact on the economy. Here are the key differences between them:

• Foreign Institutional Investment (FII):

• FIIs are institutional investors, such as mutual funds, hedge funds, pension funds, and insurance
companies, that invest in the financial markets of a country.
• FIIs primarily invest in securities like stocks, bonds, and other financial instruments for short to
medium-term returns.
• They do not acquire ownership stakes or control in the companies they invest in.
• FIIs can quickly move capital in and out of the market, which can lead to volatility in financial
markets, especially in emerging economies.
• The regulations governing FIIs are generally focused on monitoring and regulating their investments
in financial markets.
• Foreign Direct Investment (FDI):

• FDI involves the acquisition of a lasting interest in an enterprise in one country by an entity
resident in another country.
• FDI typically involves a long-term relationship between the investor and the company in
which the investment is made.
• FDI can take various forms, including the establishment of subsidiaries or branches,
mergers and acquisitions, or joint ventures.
• FDI contributes to economic growth by creating jobs, transferring technology and
knowledge, and promoting exports.
• Governments often offer incentives and establish regulations to attract FDI and ensure that
it aligns with national development goals.
• Foreign Portfolio Investment (FPI):

1. FPI involves investments in financial assets such as stocks, bonds, and other securities
by foreign individuals and institutions.
2. FPI is generally more liquid and less involved in the management of the invested
company compared to FDI.
3. FPI investors seek short to medium-term returns and may invest in multiple countries
to diversify their portfolios.
4. FPI can contribute to capital inflows, market liquidity, and asset price movements in
the host country.
5. FPI regulations typically focus on monitoring capital flows, managing exchange rate
stability, and preventing excessive speculation.
• In summary, while all three forms of foreign investment involve capital flows across
borders, they differ in terms of investment duration, purpose, impact on the economy, and
regulatory focus. FII involves institutional investors investing in financial markets, FDI
involves long-term investments in companies, and FPI involves investments in financial
assets by foreign individuals and institutions.
 DEPOSITORY RECEIPTS
• Under the Foreign Exchange Management Act (FEMA) regulations of 1999, the mechanism of
depository receipts facilitates foreign investments into Indian companies. Depository Receipts (DRs)
are negotiable securities issued by a foreign depository bank against the shares of an Indian
company, held by the custodian in India. There are two types of depository receipts mechanisms
under FEMA regulations:
• 1. Global Depository Receipts (GDRs):
• GDRs are issued by foreign depository banks outside India, denominated in foreign currencies.
• Indian companies issue GDRs to raise capital from international investors without directly accessing
foreign capital markets.
• These GDRs are listed and traded on international stock exchanges like the London Stock Exchange
(LSE), Luxembourg Stock Exchange, or Nasdaq.
2. American Depository Receipts (ADRs):
1. ADRs are similar to GDRs but are specifically issued in the United States and denominated in
U.S. dollars.
2. Indian companies issue ADRs to attract investment from American investors.
3. ADRs are listed and traded on American stock exchanges such as the New York Stock Exchange
(NYSE) or the Nasdaq.
 ANTI MONEY LAUNDERING REGULATIONS
• Money laundering, a term arising from this regulatory regime, consists of actions taken to
conceal financial movements underlying crimes ranging from tax evasion and drug
trafficking to public corruption and the financing of groups designated as terrorist
organizations.
• AML legislation was a response to the growth of the financial industry, the lifting of
capital controls, and the growing ease of conducting complex chains of financial
transactions. A high-level United Nations panel has estimated annual money laundering
flows total at least $1.6 trillion, accounting for 2.7% of global GDP in 2020.
• Anti-Money Laundering (AML) laws, regulations, and procedures reduce the ease of hiding
profits from crime.
• Criminals launder money to make illicit funds appear to have law-abiding and innocuous
origins.
• Financial institutions combat money laundering with Know Your Customer (KYC) and
Customer Due Diligence (CDD) measures.
• Money laundering can be divided into three steps. The KYC process aims to stop money
laundering at the first step when customers attempt to store funds in financial accounts.

• Depositing illicit funds into a financial system.

• Placing a series of transactions, usually repetitive and voluminous, to obfuscate the illicit
origin of the funds known as "layering."

• "Cleaning" and "washing" the funds by converting them into real estate, financial
instruments, commercial investments, and other acceptable assets.
• During the KYC process, financial institutions will screen new customers against lists of
parties that pose a higher than average risk of money laundering: criminal suspects and
convicts, individuals and companies under economic sanctions, and politically exposed
persons, which encompass foreign public officials and their family members and close
associates