Finance ministry exempts mutual funds from foreign-investor status

Govt has modified circular that classified MFs as investment vehicles

The finance ministry has clarified to foreign-owned mutual funds (MFs) that they will not be categorised as foreign investors and subjected to sectoral caps under the Foreign Exchange Management Act (Fema).

Last October, a circular had notified rules with regard to foreign investment in non-debt instruments, classifying mutual funds with over 50 per cent equity as “investment vehicles”.

This meant that downstream investment by such funds by way of subscription or acquisition of shares would have been considered “indirect foreign investment” if their investment manager or sponsor is owned or controlled by a non-resident.

The finance ministry has now said that mutual funds that invest more than 50 per cent in equity shall be omitted from the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996.

The changes notified in October had got foreign-owned MFs worried that their investments through equity schemes would have been impacted if the norms were made effective. Foreign-owned funds would have had to adhere to the sectoral caps and restrictions applicable to foreign investment in Indian equities. This would have put them at a significant disadvantage vis-à-vis domestic funds, limiting their investments in stocks and dragging down overall returns.

The foreign funds that could have been impacted included Mirae Asset, Principal MF, Nippon India MF, Franklin Templeton MF, and Invesco MF. HDFC Mutual Fund and ICICI Prudential MF might have also been impacted.

Concerned about the fallout of these restrictions, several fund houses had approached Sebi and finance ministry.

The restrictions would have also made it impossible for exchange-traded funds to invest according to assigned weightage of the underlying benchmarks, without breaching sectoral caps.

Listed stocks are subject to certain sectoral caps with regard to foreign ownership. For example, banking stocks have a 74 per cent foreign direct investment and foreign institutional investor cap. The ruling would have barred foreign-owned fund houses from investing in sectors after the limit was breached, while domestic fund houses would have no such limits.  

It might have potentially also put brakes on fresh money coming into schemes of foreign fund houses and would have led to investor assets moving towards domestic mutual fund houses.