End discrimination against Indian fund managers

WITHOUT CONTEMPT

Yet another Pravasi Bharatiya Diwas has gone by. The Prime Minister has made the usual sounds about the power of Indian origin, even taking up for foreigners of Indian origin in Malaysia.

However, in the Indian capital markets, the government is unable to get its act together, and if reports are to be believed, this is despite the best intentions of the regulator.

In 2000, a provision was inserted in the Securities and Exchange Board of India (Foreign Institutional Investors) Regulations ("FII Regulations") prohibiting non-resident Indians ("NRIs") and overseas corporate bodies ("OCBs" "" any foreign entity in which NRIs own 60% or more beneficial interest) from being registered as foreign institutional investors ("FIIs") or as sub-accounts of FIIs.

The intention then was that NRIs and OCBs were free to invest on Indian stock exchanges without having to be licensed or registered with Sebi.

The FII framework was a special dispensation given to foreign persons who were not NRIs or OCBs and were desirous of investing in Indian securities.

The amendment to the FII Regulations was quite logical then since there was little point in letting NRIs and OCBs to also register as FIIs and adopt a special dispensation, even while yet another special and more liberal dispensation was available to NRIs and OCBs to invest in India

In 2003, when it was suspected that resident Indians (not NRIs) were routing their private-banking money and funds stashed away abroad through OCBs into India, the special recognition accorded to OCBs under Indian exchange controls was taken away.

Therefore, OCBs lost their regulatory freedom to invest in Indian stock exchanges. Therefore, the potential regulatory confusion that was sought to be addressed in 2000 by amending the FII Regulations ceased to be a possibility.

In fact, at this stage, removing the prohibition on OCBs applying for registration as FIIs or sub-accounts would have provided a framework whereby OCBs could have been permitted to invest in India and be made directly accountable to an Indian regulator.

In other words, the regulatory dispensation would have become far superior and Indian regulators would have had direct supervision and oversight powers over any OCB that got registered as an FII. However, policy-makers forgot about this provision in the FII Regulations.

Today, the prohibition has come to pose a completely unintended consequence. The regulator is now in a quandary over whether to register funds managed by persons of Indian origin as FIIs or sub-accounts. Since the prohibition is only on OCBs and NRIs getting themselves registered as FIIs or sub-accounts, SEBI has already registered several funds which do not constitute OCBs, but may be managed by persons of Indian origin.

Unless the unitholders of a fund applying for registration comprises NRIs to the extent of at least 60 per cent of the fund size, it would not be an OCB and therefore would not be barred from registration as an FII or a sub-account. However, it is reported that recent efforts to delete the 2000 amendment to the FII Regulations have been opposed.

Suddenly, the regulator is unsure of registering as FIIs, funds that confer investment management rights on asset management companies / investment advisory companies ("AMCs") that are promoted by persons of Indian origin. So long as the beneficial ownership of an applicant fund itself is in non-Indian hands, and more than 60 per cent beneficial ownership is in non-NRI and non-OCB hands, there is no case for preventing market access in the form of an FII registration.

Failure to address this anomaly would lead to Indian policy persisting with reverse discrimination against people of Indian origin. Even from a technical legal perspective such policy is anomalous. Resident Indian AMCs and portfolio managers are permitted registration as FIIs. Similarly, funds registered as FIIs that are managed by AMCs not owned by Indians, merrily employ Indian fund managers. There is no case to disqualify funds managed by Indian-owned AMCs "" it would only fetter the spirit of Indian entrepreneurship.

(The author is a partner of JSA, Advocates & Solicitors. The views expressed herein are his own.)

somasekhar@jsalaw.com