Clash of the titans: Foreign investment regulation in India

The Sebi-RBI face-off on foreign investments is a classic case of overlap that has led to contradictory rules set by different regulators

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Overlap in regulations seriously affects their efficacy and regulation of foreign investment in India provides an interesting case study in this regard. The Securities and Exchange Board of India (Sebi) and Reserve Bank of India (RBI) have been working independently towards rationalising the existing investment regime to make it more investor-friendly. This shift in attitude is evident with the introduction by Sebi of Qualified Foreign Investors (“QFIs”) as a new class of investors, the promulgation of the Sebi (Alternative Investment Fund) Regulations, 2012 and permission granted by RBI to Foreign Venture Capital Investors (FVCIs) to participate in secondary transactions. In addition, RBI has allowed FVCIs to be active participants in stock exchanges which seems to encroach on the monopoly of Foreign Institutional Investors (FIIs) regulated by Sebi.

FVCIs were permitted invest in venture capital funds and Indian venture capital undertakings, which are defined to mean companies not listed on a recognised stock exchange and to invest up to a third of their investible funds in preferential allotment by listed companies. RBI’s circular dated 19 March 2012 extended this, allowing FVCIs to invest in eligible securities by way of private arrangement, purchase from a third party or by investing in securities on a recognised stock exchange. Although the RBI Circular issued in this respect attempts to liberalise investments made by FVCIs in India, it is subject to provisions of Sebi Regulations, which currently don’t allow FVCIs to invest in the manner permitted by RBI’s Circular.

The Sebi (Alternative Investment Fund) Regulations, 2012 (AIF Regulations), defines an Alternative Investment Fund (AIF) to mean any fund established or incorporated in India which collects funds from domestic and/or foreign investors for investing the funds in accordance with a defined investment policy. However, the consolidated Foreign Direct Investment Policy effective from 10 April 2012 does not permit foreign investments in AIFs. While, the Department of Industrial Policy and Promotion (DIPP) has in the last one year, issued clarifications and made changes to the FDI Policy, none of the press notes issued till date mention the possibility of foreign investments in AIFs.

In addition to this, the AIF Regulations created a category of AIFs that would be eligible for tax benefits. However, the government has not announced any benefits or conditions for funds to qualify as such AIFs so far. A similar disconnect is seen in the regime for QFIs who were allowed to invest in the Indian equity and debt markets to boost foreign investment in the country. However, this route hasn’t seen much success due to the skepticism surrounding the tax risk for depositories whose clients are QFIs.

This is not a one-off phenomenon but percolates most areas of commercial regulation. Overlap between the provisions of the Companies Act, 1956, the Securities Contract (Regulation) Act, 1956 and the Sebi Act, 1992 sometimes leads to contradictory regulations issued by different regulators in the same area of regulation. This militates against the need for a consistent regulatory approach. Another example was the controversy surrounding who should regulate unit linked insurance plans with the issue finally being decided in favour of the Insurance Regulatory Development Authority (Irda) over Sebi.

It is experiences like these that lend credibility to the widely held perception that rather than being an example of the rule of law, India suffers from a tyranny of laws and a lack of policy.  What we have seen is a number of ad hoc measures from different parts of government which make for excellent sound bites but have had no perceptible effect on status quo. It almost makes it seem like the government is a benevolent monarch and various regulators are feudal lords with significant autonomy which seems to manifest itself in the way they undermine each other.

-- Murali Neelakantan is a Partner and Nidhi Killawala is an Associate at Khaitan & Co, a law firm