A study on Qualified Foreign Investments (QFI): the system and its benefits to Foreign Nationals

FORMAT OF INDUSTRY ASSIGNMENT

1 Title of the Industry Assignment
2 Key Words
3 Executive Summery
4 Table of Contents
5 Exhibits
6 Figures
7 Introduction
8 Literature Review
9 Analytical Interpretation on the topic ( your contribution )
10 Suggestions
11 Conclusion






















Definitions
2.1 Authorised bank
Authorized Bank means a bank including a co-operative bank
(other than an authorized dealer) authorized by the Reserve
Bank to maintain an account of a person resident outside India .
2.2 Authorized Dealer
Authorized Dealer means a person authorized as an
authorized dealer under sub-section (1) of section 10 of FEMA.
2.3 Authorized Person
Authorized Person means an authorized dealer, money
changer, offshore banking unit or any other person for the
time being authorized under Sub-section (a) of Section 10 of
FEMA to deal in foreign exchange or foreign securities.
2.4 Capital
Capital means equity shares; fully, compulsorily &
mandatorily convertible preference shares; fully, compulsorily
& mandatorily convertible debentures. (*Note : Warrants and
partly paid shares can be issued to person/ (s) resident outside
India only after approval through the Government route).
2.5
Capital Account
Transaction
Capital account transaction means a transaction which
alters the assets or liabilities, including contingent liabilities,
outside India of persons resident in India or assets or
liabilities in India of persons resident outside India, and
includes transactions referred to in sub-section (3) of section
6 of FEMA.
2.6
Company Controlled by
Indian residents
A company is considered as Controlled by resident Indian
citizens if the resident Indian citizens and Indian companies,
which are owned and controlled by resident Indian citizens,
have the power to appoint a majority of its directors in that
company .
2.7 Depository Receipt
Depository Receipt (DR) means a negotiable security
issued outside India by a Depository bank, on behalf of an
Indian company, which represent the local Rupee
denominated equity shares of the company held as deposit by
a Custodian bank in India. DRs are traded on Stock
Exchanges in the US, Singapore, Luxembourg, etc. DRs listed
and traded in the US markets are known as American
Depository Receipts (ADRs) and those listed and traded
anywhere/elsewhere are known as Global Depository
Receipts (GDRs).
2.8 OCB
Erstwhile Overseas Corporate Body (OCB) means a
company, partnership firm, society and other corporate body
owned directly or indirectly to the extent of at least sixty
percent by non-resident Indian and includes overseas trust in
which not less than sixty percent beneficial interest is held by
non-resident Indian directly or indirectly but irrevocably and
which was in existence on the date of commencement of the
Foreign Exchange Management (Withdrawal of General
Permission to Overseas Corporate Bodies (OCBs) )
Regulations, 2003 (the Regulations) and immediately prior to
such commencement was eligible to undertake transactions
pursuant to the general permission granted under the
Regulations.
2.9 FDI
FDI means investment by non-resident entity/person
resident outside India in the capital of an Indian company
under Schedule 1 of Foreign Exchange Management
(Transfer or Issue of Security by a Person Resident Outside
India) Regulations 2000 (Original notification is available
athttp://rbi.org.in/Scripts/BS_FemaNotifications.aspx?Id=174.
Subsequent amendment notifications are available at
http://rbi.org.in/Scripts/BS_FemaNotifications.aspx)
2.10 FEMA
FEMA means the Foreign Exchange Management Act 1999
(42 of 1999) (http://finmin.nic.in/law/index.asp).
2.11 FIPB
FIPB means the Foreign Investment Promotion Board
constituted by the Government of India.
2.12 FII
Foreign Institutional Investor(FII) means an entity
established or incorporated outside India which proposes to
make investment in India and which is registered as a FII in
accordance with the Securities and Exchange Board of
India (SEBI) (Foreign Institutional Investor) Regulations
1995.
2.13 Government Route
Government route means that investment in the capital of
resident entities by non-resident entities can be made only
with the prior approval of Government (FIPB, Department of
Economic Affairs (DEA), Ministry of Finance or Department
of Industrial Policy & Promotion, as the case may be).
2.14 Indian company
Indian Company means a company incorporated in India
under the Companies Act, 1956.
2.15 Investing Company
Investing Company means an Indian Company holding
only investments in other Indian company/ (ies), directly or
indirectly, other than for trading of such holdings/securities.
2.16 Non-Resident Entity
Non resident entity means a person resident outside India as
defined under FEMA.
2.17 NRI
Non Resident Indian (NRI) means an individual resident
outside India who is a citizen of India or is a person of Indian
origin.
2.18
Company owned by
Indian Resident
A company is considered as Owned by resident Indian
citizens if more than 50% of the capital in it is beneficially
owned by resident Indian citizens and / or Indian companies,
which are ultimately owned and controlled by resident Indian
citizens;
2.19
Portfolio Investment
Scheme
Portfolio Investment Scheme means the Portfolio
Investment Scheme referred to in Schedules 2 & 3 of FEM
(Transfer or Issue of Security by a Person Resident Outside
India) Regulations 2000.
2.20 QFI
A Qualified Foreign Investor (QFI) means a non-resident
investor (other than SEBI registered FII and SEBI registered
FVCI) who meets the KYC requirements of SEBI for the
purpose of making investments in accordance with the
regulations/orders/circulars of RBI/SEBI.
2.21 RBI
RBI means the Reserve Bank of India established under the
Reserve Bank of India Act, 1934.
2.22 SEBI
SEBI means the Securities and Exchange Board of India
established under the Securities and Exchange Board of India
Act, 1992.
2.23
Assets Under
Management
Assets under management (AUM) denotes the market value
of all the funds being managed by a financial institution (a
mutual fund, hedge fund, private equity firm, venture capital
firm, or brokerage house) on behalf of its clients, investors,
partners, depositors, etc.
3.Exhibits


Exhibit 3.1 Capital Control in India


























Exhibit 3.2 - FII flows ,circa 2002-2010












Exhibit 3.3-Representation of the proposed QFI framework
















4.Figures
Figure 4.1 World Governance Indicators for developing nations












Figure 4.2 Current account flows to GDP (Capital account integration)

















Figure 4.3 Average assets under management



Figure 4.4- Category wise growth in assets under Management














Figure 4.5- Investors in the equity and non-equity categories























5.Background of the Issue in study.
5.1 A snapshot of the Indian economy
1.India is ranked 132nd out of 183 economies in Doing Business 2012, recording an increase of 7
points compared to last year. This increase reflects large improvements in the Paying Taxes,
Resolving Insolvency, and Getting Electricity indicators.
2. According to the latest Enterprise Surveys (2006), Electricity, Tax Rates and Corruption represent
the top 3 obstacles to running a business in India.
3. Indias restrictions on foreign equity ownership are greater than the average of the countries
covered by the Investing Across Sectors indicators in the South Asia region and of the BRIC (Brazil,
Russian Federation, India, and China) countries. India imposes restrictions on foreign equity
ownership in many sectors, and in particular in the service industries.
4. Indias economic freedom score is 54.6, making its economy the 123rd freest in the 2012 Index. Its
score is unchanged from last year, with an improvement in labor freedom offset by declining scores
in five other areas including business freedom, freedom from corruption, government spending,and
monetary freedom. India is ranked 25th out of 41 countries in the AsiaPacific region, and its overall
score is below the world average.
In 2010, a report by the world bank on the Indian Business environment, that talked about
Investing across borders, read:
Indias restirction on foreign equitty ownership are above the average of the countries covered by
the investing across sectors indicators in the south Asia region and of the BRIC countries. India
imposes restrictions on foreign equity ownership in many sectors, and in particular in the service
industries. Sectors such as railway freight trasportation and foresttry are dominated by public
monopolies and are clsoed to foreign equity participation. With the exception of certain activites
specified by law, foregin ownership in the agriculture sector is also not allowed. Gorreign ownership
of pulishing companies aren newspapers is limited to a maximum of 26%. In the financial services
sector, foreign capital participation in local banks is limited to 87% and in insurance companies to
265. Furthermore , oerign ownership in the telecomunications sector is limited to a less than 75%
stake.
In other words, by the end of 2010 , by global parameters, the Indian outlook was starting to
dwindle; while internally, the economy was doing fairly well, there was little scope for those outside
the system to contribute to it. Conseqently, the spectrum of the indian financial sector remained
limited; and this starting leading to stagnation.
Rewinding back to 1991. The times were as bad as they could be; the economy was in doldrums; the
balance of payments crisis was at its peak and India did not even have enough forex to probably
support its imports for more than 15 days. Those were the times that had called for desperate
measures; and that was the time which marked Indias foray into the global financial market. From
then, the economy opened up, albeit at a snails pace, to foreign investments; FDIs; capital inflows;
a free-er currency; and thus, in a nut shell, propped up all the macroeconomic factors needed to
propel a country to positive growth, keeping inflation in control and unemployment at bay.
However, given that India has a behemoth population and conceded that the political and social
conditions in India were NOT conducive to blazing growth, the growth story of India has, time and
again, been spersed with joblessness, slow growth, high inflation, unstable governments, fluctuating
rupee, poor manufacturing figures, and red taping. This has meant that not all policies or economic
measures have been able to spread their wings properly; and intuitively, on the flip side, it suggests
that India is yet to reach full potential, and is not even half way through. Or, in other words, times
call for even a bigger slew of measures and more defiant, cognitive steps to freeing up the economy.
5.2 The entry of the Qualified Foreign Investors
The year 2011 was not a great year for the Indian economy. The year started with robust projections
of 8.5% growth in GDP, however by year end the figure has been revised to 7%. To make matters
worse, political disunity and slow decision making (if any) over crucial issue of FDI and a depreciating
rupee has ensured the year ended in economic gloom.
However, on January 1, 2012 the central government took an important decision of allowing QFIs to
invest directly in Indian stocks- a decision that had the potential to directly impact the quality of
foreign investments in India and ensure stability in Indian markets. The first day of this year-January
1, 2012 should probably be declare, in line with existing traditions, as QFI Day in our country. It is the
day when Ministry of Finance (hereinafter referred to as Ministry) vide its press note, permitted QFIs
to invest directly in Indian Equities Market.
Prior to this circular QFIs were allowed to invest in India but only in the Mutual Fund segment
;Having received the licence to invest directly into equities market now meant that QFIs can
themselves select the scripts they wish to invest in, unlike investing in Mutual Funds, where the fund
chooses the scripts in which the money is to be invested.But Before we delve into the regulatory
framework and implications involved in this system,there is an interesting episode behind having
this new class of investors. Since the 1991 liberalization policy, various modes of investments were
made available to the foreigners. These included the foreign direct investment (FDI), foreign
institutional investment (FII), non-resident Indian (NRI) investment, overseas corporate body (OCB)
investments and later the foreign venture capital investments (FVCI).Having these number of class of
investors led to overlapping of regulatory regime governing them. Further, the availability of
multiple routes caused uncertainties to foreign investors when it came to opting for the appropriate
investment route to adopt in order to invest in India. To address these issues, the Working Group on
Foreign Investments in India published a report on 30 July, 2010. Inter alia, the report recommended
consolidating the above mentioned group of investors into one class that shall be called- QFIs.
Interestingly, what actually was done is that QFIs were introduced in addition to the existing class of
investors. Thus inspite of acting on the recommendation to consolidate them, the Ministry went on
to introduce an additional route to invest in the country. Thus this marked the opening of QFIs in the
country.The prime reasons to add another class of investors as stated by the Ministry were:-
a) To widen the class of investors,
b) Attract more foreign funds,
c) To reduce market volatility and,
d) To deepen Indian Capital Market.
It should be remembered that prior to this only FIIs/sub accounts and NRIs were permitted to invest
in Indian Equity directly.




5.3 QFI-Understanding the system.(Exhibit 3.1)
As per the initial circulars, a QFI meant any person that
Is not a Resident of India or not a SEBI(Securities Board Of India) registered Foreign Institutional
Investor (FII)/Sub Account /Foreign Venture Capital Investor(FVCI);
Is a resident of a country other than India, which is a member of Financial Action Task Force (FATF)
or a member of a group which is a member of FATF and is signatory to International Organization of
Securities Commissions (IOSCOs) Multilateral Memorandum of Understanding or a signatory of a
bilateral MOU with SEBI.
The Securities and Exchange Board of India SEBI, in consultation with Government of India and
Reserve Bank of India later decided to amend its earlier provisions with respect to Foreign Investor
in mutual funds and equity share markets. As per the new definition,resident of a country that is a
member of a group which is a member of FATF will also be eligible to be considered as QFI.
Therefore, all the residents of the 6 member countries of the Gulf Cooperation Council and the 27
member countries of the European Commission would now be eligible to be considered as QFI.
For this purpose, the term Person has the same meaning under Section 2(31) of the Income Tax
Act, 1961 (ITA) as well as the Foreign Exchange Management Act (FEMA) 1999. As per this definition,
Individuals, Partnership Firms, Hindu undivided family, Companies, Trusts, Association of Persons
and Body of Individuals fall within the purview of Person. Therefore, technically, any of these
entities are entitled to invest as QFIs subject to fulfillment of other conditions.
Types of investments that can be made by QFIs :
Equity shares
Rupee denominated units of equity schemes of domestic Mutual Funds(MFs)
Domestic Mutual fund debt schemes in infrastructure debt
Debt securities
Qualified Foreign Investors (QFIs) in Listed equity share investments-The Foreign Investors who are
Qualified i.e., the QFIs are allowed to purchase on repatriation basis equity shares of Indian
companies subject the following terms and conditions:
a) QFIs shall be permitted to invest through SEBI registered Depository Participants (DPs) only in
equity shares of listed Indian companies through recognized brokers on in equity shares of Indian
companies which are offered to public and in India recognized stock exchanges in India in terms of
the relevant and applicable SEBI guidelines/regulations.
b) QFIs shall also acquire equity shares by way of bonus shares, rights shares or equity shares on
account of stock split / consolidation or equity shares on account of merger, demerger or any such
corporate actions relating to investment limits.
Depository participants: (Exhibit 3.3)
A Depository Participant (DP) is basically an agent of the depository. They can be called as the
intermediaries between the investors and the depository. The relationship between the depository
and the depository participants DPs is governed by an agreement made between the two under the
Depositories Act. In legal sense, a DP is an entity who is registered with SEBI and under the sub
section 1A of Section 12 of the SEBI Act. These are the following parameters to be fulfilled by
registered DP under SEBI for becoming a Qualified Depositary Participant:
DP should have a available means of Rs. 500 million or more
It shall be either a clearing bank or clearing member of any of the clearing corporations
It shall have appropriate arrangements for receipt and payment of money with a assigned
Authorised Dealer (AD) of Category I bank
It shall also demonstrate about the systems and procedures it has which have to be
complied with the FATF Standards, Prevention of Money Laundering Act (PMLA), other Rules
and circulars issued from time to time by SEBI.
Also it shall obtain a prior approval from SEBI before the commencement of its activities
relating to opening of dematerialized accounts by QFIs and shall ensure that QFIs meet all
the requirements, as per the relevant rules and regulations issued by SEBI from time to time.
QFIs shall pay money through normal banking channel in any permitted currency (i.e.the
currency which is freely convertible) directly to the single rupee pool bank account of the DP
maintained with an Assigned Authroised Dealer of category I bank. On receipt of
instructions from QFI, DP shall carry out the transactions relating to purchase and sale of
equity).
Sale of acquired equity shares by QFI :-
QFIs can sell their equity shares which are acquired by way of sale in the following ways:
through recognized brokers on recognized stock exchanges in India; or
In an open offer in accordance with the SEBI (Delisting of Securities) Guidelines, 2009; or
In an open offer in accordance with the SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations, 2011; or
By the way of buyback of shares by a listed Indian company in accordance with the
SEBI (Buyback) Regulations, 1998.
Tax implications:
At present, there are no specific provisions in the Indian Income Tax Act, 1971 relating to QFIs. The
primary reason for this is that the Government has finalized its guidelines and also issued the SEBI
circular only recently. It is likely that in the next Finance Act, there would be some amendments in
the IT Act relating to QFIs. In the meantime, one would need to apply the normal provisions
contained in the ITA to the income earned by QFIs from the investments made in Indian mutual
funds and equities. while doing so, there is a need to check whether the QFI is entitled to the benefit
of any Double Tax Avoidance Agreement (DTAA) signed by India with such country. If it is so then the
QFI is entitled to take appeal to the provisions of the DTAA or the domestic law whichever is more
beneficial. As per the Income Tax laws in india, the taxation of the income earned by a QFI is
considered as Income from dividend declared by Indian companies.
Limitations on QFIs-The QFI investments are subjected to certain limitations:
The investment by QFI would be subjected to an individual investment limit of 5% of the
paid-up capital of the Indian company and aggregate investment limit of 10%.
QFI can open only one demat account with any one of the DPs. Selling and buying of equity
shares is done only through that DP.
Coming to joint accounts, every holder shall individually meet the requirements prescribed
specifically for QFIs.
QFIs investment will be taxed at the same rate as the Indian investors, which means
Qualified DP deduct TDS at the short term rate for QFIs at the time of remittance of the sales
proceeds.
QFIs are not eligible to subscribe to any Systematic Investments or Transfer or Withdrawal
plans.
They can subscribe to or redeem only to their units.
Units held by QFIs by way of Usable Capital Receipts and Demat holding are neither
transferable nor tradable.
QFIs are not allowed to do off shore transfers of securities.
The investments bought cannot be pledged or placed in lien and they should be free from
encumbrances.
QFIs cannot engage in activities like lending and borrowing of any kinds of funds or
securities.






































6. Analytical interpretation of the situation: The Indian side
and the Foreign National side

Any move that connects the country to the rest of the world always has two players to the
game- the national economy, and the external investors/producers/economies, depending
on the scale of the transaction. Relations with other economies result in the creation of
current accounts and capital accounts; relations with producers result in exchange and
transfer of technology; and the relation with the external investor, the most volatile of all,
results in the creation or flight of capital, as the case may be. Simply speaking, for an
emerging nation like India, with a burgeoning national economy and generally positive
macro-economic indicators, internal investors form a major part of the present picture as
the country has been slow in opening itself up in order to protect its fledgling economy from
the vicissitudes of external trade and investment; But as was discussed previously, this stand
has now evolved to include more of free trade and investment, which has been seen in the
form of relaxing norms on FDI and FII flows.
While FDI flows are of a slightly more permanent nature, depend mainly on trade terms,
internal policies, political stability and offer long-term, stable gains to the investor and asset
creation to the destination of investment (India, in this case),flow of capital is of a more
transient nature and depends on more critical macro-factors like the interest rate, general
market sentiments, and offers immediate, large scale returns to the investor, and capital
inflows/ better nominal exchange rate to the investee. And this is where QFI, a slightly
drilled down version on institutional investing that focuses mainly on the individual
investing rather than on institutional investing, comes in . Just like institutional investing
provides a fillip to the financial markets of a nation, and generally rallies market sentiments,
Individual investing by high net-worth individuals also have the ability to boost stock prices,
help in capital inflows, push up industrial capital, and thus increase production as well as
growth. Having said that from the point of view of the nation, a lot can also be said about
the unbound returns and advantages to the individual investor, given than any emerging
nation is always grossly undervalued and has the ability to outperform any benchmark or
any prediction that may be targeted. And this is what the following few pages will do-
analyse this phenomenon of Qualified foreign investing from two perspectives, the nation
and the investor, and thus try to reach a common ground that works best for both.

6.1 The Indian side

Foreign investment laws have been enacted in economies in transition in order to
encourage and protect foreign investments. Some countries, such as Kazakhstan, Uzbekistan
and Kyrgyzstan, have now adopted revised foreign investment laws that offer investors
essential guarantees and protection. The Kyrgyz Republics new Law On Foreign
Investments provides foreign investors with a just and equal legal regime, full and
continuous protection, guarantees of nondiscrimination, protection against expropriation of
foreign investments, and the right to freely dispose of their investments and of income from
them, as well as compensation for losses to foreign investors in the event of armed conflict
or other such circumstances. Consequently, efforts in these countries to improve legislation
on foreign investments are oriented toward the creation of an overall legal system that is
consistent with international standards and that incorporates elements regulating domestic
investments as well. Transition economies have also concluded numerous international
agreements on investment protection. Most of the elements of these agreements are
reflected in their foreign investment laws. Nevertheless, these international agreements on
investment protection take precedence over the countries national foreign investment
laws, since guarantees and concessions for investors, in keeping with national legislation,
can be rescinded by the enactment of a different law, while guarantees and concessions
established by an international treaty cannot be altered or rescinded by a host country
unilaterally. Therefore, economies in transition need to be more active in signing
international treaties on investment protection and in harmonizing their own foreign
investment laws with such treaties. The OECD countries recently signed a multilateral
agreement on investments that contains strict criteria as regards liberalizing investment and
investor-protection regimes and includes effective dispute resolution procedures and many
key elements of international treaties and agreements on investment activity that are
already in effect. The treaty is open for signing by all interested countries, including
transition economies. Since the world community is moving in the direction of recognizing
international standards and criteria to govern foreign-investment regimes, it is extremely
important that economies in transition have the same base elements in their foreign
investment legislation.
However, One of the causes of the low level of foreign participation in privatization is the
fact that transition economies have insufficient expertise in attracting foreign investors. As a
result of these countries inexperience and a lack of assistance in searching for foreign
investors, the task of finding qualified foreign buyers for enterprises has proved to be a
serious problem. In addition, existing restrictions on DFIs(direct foreign investments), and a
lack of information about enterprises being offered for sale have had a negative effect. For
this reason, as they continue to implement privatization, economies in transition need to do
a better job of marketing, identifying potential foreign investors and providing them with
complete information about investment opportunities.
Putting the above into perspective, the decision to allow QFIs to directly invest in Indian
stocks holds a lot of promise for the Indian industry, especially as Indian companies are
increasingly getting global. For instance, infrastructure major L&T is investing heavily in gulf,
so an investor in Gulf States would be more aware of L&T and will invest in it. If we consider
IT major Infosys, an investor in US can now directly invest in it- so the investor must be
aware of the companys strengths and long term growth prospects and hence will most
likely be for medium to long term, thus ensuring stability for the company. However for this
scheme of things to be successful, there needs to be wider participation of state owned
banks and also forging partnerships with entities like Abu Dhabi Commercial Bank which are
better equipped to handle the KYC norms for local investors.
This seems to be the right way forward now, because having toyed around with FDI and FII,
this is another major aspect that has been wanting attention for sometime now. By allowing
foreign investors, with a large individual disposable income, to invest into the country, the
regulator is not only ensuring a back-up supply of capital, but also letting the stock market
adjust to more informed ways of performance, given that foreign investors are naturally
better disposed to information and technology; and after the initial hiccup of a new market,
can use it to significantly get better gains out of an investment. Further, this has a positive
spiralling effect, because as investors invest, confidence grows; and as confidence grows,
the market burgeons , sends out positive signals, and thus attracts even more investment,
private, institutional or otherwise. The third, slightly compounded effect that QFIs may
have is reducing the effect of hot-money flow through institutional investors, and the
hammering it produces on the Indian currency. By allowing QFIs, a greater leeway is made
for capital inflows; and the inflows will now not just consist of institutional investments, but
private investment as well; and thus when sentiments turn rough, the flight of capital will
not be as pronounced, given than foreign individual investors tend to wait and watch more
and are less sensitive to fluctuations. This will provide a buffer for the rupee, and thus
absorb a bit of the shock that negative sentiments can produce,and consequently, will help
shore up the rupee in rough weather by adding to the forex reserves in the country.

6.2 The Foreign national side.
As much as we may talk about the Indian side of it, the truth remains that foreign investors
need to be given a reason to invest in this country; and they need to be convinced of the
go-to potential of the Indian economy as a source of stable, persistent and continued
returns.

Exhibit 3.2 depicts the flow of FII into India, with a reference to the 2008 crisis, when
it was at its lowest. Now while 2008 was a year of lows with the stock markets round
the world tumbling and gains crashing, India continued to be steady. Growth was
positive, and infact continued to reach new highs; thus at a time when global
markets were burning, India continued to prosper and provide returns to anyone
who put faith in its economy. This is perhaps the strongest indicator of why a foreign
national should invest in India. With a robust economy , large population, strong
technology base that is growing, minor hiccups cannot really derail its progress.
Admittedly, currency fluctuations have dogged the country in recent times; but even
these are temporary, and it is very such investments that will help the country tide
over such factors and provide better ROI to the prospective investor.
Figure 4.1, which shows global