| FIIs are a special class of investors that are given special permission under Indian exchange controls to freely buy and sell shares on Indian stock exchanges. The Securities and Exchange Board of India (Sebi) registers FIIs and the Reserve Bank of India (RBI) recognises FIIs as investors that can freely remit funds into and outside India for purposes of such transactions. On the other hand, non-FII foreign investment, including investment from non-resident Indians (NRIs), is treated as FDI. |
| FIIs, which are considered institutional portfolio investors under the special dispensation, are not normally fettered by restrictions such as those imposed under the infamous Press Note 18 or its new version, Press Note 1 (which entail consent of existing investee companies when a fresh investment is made). It is not contemplated that an FII would have to take the consent of every company whose shares it holds whenever it wants to purchase any shares in a company in the same or allied field. |
| So also, FIIs are institutional investors "� often, broad-based funds that represent a diversified interest in the investments they make. On the other hand, investors that invest in the capital for strategic purposes "� say, Unilever holding shares of Hindustan Lever Ltd "� represent FDI. Using this differentiation, in several sectors where foreign ownership is regulated, there is a distinction between FII holdings and FDI holdings, and the government has capped the maximum FDI holding permissible in a company even while insisting that the residual foreign holding within an overall cap can only be done by FIIs. This is also bolstered by the fact that under regulations made by Sebi, the maximum stake that a single FII can hold in an Indian company is capped at 10 per cent of the equity share capital. |
| Now, while this appears to be a simple basis to differentiate between the two streams of capital, life is not so simple. FIIs are free to issue participatory notes and other such derivative instruments to other investors abroad, with full disclosure to Sebi about such holders of derived instruments. So, there is no real need to restrict the overall FDI in any sector in order to ensure diversified ownership. The government can simply bring in laws that ensure demutualised holding in sectors that it considers sensitive. |
| For instance, in the banking sector, regardless of whether an investor has holdings in the form of FDI or FII, no person can hold more than 5 per cent of the equity without the RBI's consent. This principle is also being followed now by Sebi in the case of foreign equity holding in stock exchanges and depositories. |
| Artificial differentiation between sources of capital lead to artificial structures that enable one to overcome legalistic restrictions keeping the spirit in mind. At times, the spirit too gets violated, and ambiguity over the law leads to enormous avoidable hardship. In fact, the treatment meted out to companies owned by NRIs is a case in point. Any foreign company in which NRIs own 60 per cent or more is an overseas corporate body (OCB). Initially, the foreign investment policy gave them a slew of incentives. Merely because some residents violated the law, instead of punishing the offenders, all benefits made available to such OCBs were taken away. The letter of the law in exchange controls makes an OCB ineligible to even freely participate in a rights issue by an Indian company. |
| An RBI press release suggests that benefits otherwise available to foreign companies would continue to be available to OCBs, but the legal provisions in the regulations made by statute remain unaltered. If public interest litigation is initiated against any transaction, courts would have to uphold the regulations and not the press release. It is time to remove artificial distinctions of capital and let unfettered flow of funds. Any regulation of specific sectors should be left to special regulators and not be done through the government's foreign investment policy. |
| The author is a partner in JSA, Advocates & Solicitors. The views expressed herein are his own |
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