Mutual funds give FEMA reporting a miss, await govt clarity on the issue

Mutual funds have to adhere to restrictions applicable to foreign investment

None of the foreign-owned or controlled mutual funds (MFs) have fulfilled their reporting obligations as mandated by the new Foreign Exchange Management Act (FEMA) norms notified a month ago, pending clarity from the government on the issue. 

“There was a reporting deadline that ended on Friday and the funds had to report according to the changed law. Every day that we don’t report is technically a breach of the new guidelines,” said a senior fund official, on condition of anonymity. 

Fund houses have decided to maintain status quo following assurances from the Securities and Exchange Board of India (Sebi) as well as custodians that the guidelines impacting MFs would be amended soon. The Association of Mutual Funds in India, an industry body, had asked Sebi to look into the matter a few days ago, post which the regulator wrote to the finance ministry on the issue. Several fund houses also made representations to the economic affairs department. 

“The reporting obligations have kicked in, but the fund houses seem to have taken a call not to go ahead with the same,” said a second person.

According to the new norms, foreign MFs have to adhere to sectoral caps and restrictions currently applicable to foreign investment in Indian equities. 

The FEMA saga

• Centre amends FEMA norms on October 17
• MFs classified as investment vehicles
• Industry body Amfi raises concerns with Sebi
• Fund houses make representations to the economic affairs department
• Sebi writes to FinMin flagging the issue
• Fund houses given verbal assurances that issue will be addressed
• MFs give reporting deadline a miss

MFs making downstream investments have to furnish details of their equity investments to the Department for Promotion of Industry and Industrial Trade within 30 days of investment even if the equity instruments have not been allotted. 

MFs also have to file form DI with the RBI within 30 days from the date of allotment of equity instruments.

According to the fund official, if the existing guidelines remain unchanged, the government will have to come up with additional clarifications, specifying the conditions and the manner in which funds have to meet the sectoral caps. 

“What happens to existing investments in certain stocks? Assuming several funds are in breach of the caps, which ones will be required to offload their holdings and in what proportion?” he said. 

The amended FEMA norms classify MFs that invest more than 50 per cent in equity as ‘investment vehicles’. 

Downstream investment by such funds by way of subscription or acquisition of shares is considered ‘indirect foreign investment’ if the investment manager or sponsor is owned or controlled by a non-resident.

Mirae Asset and Principal MF are the two foreign fund houses, which may immediately get impacted by the new FEMA norms. These fund houses have equity assets in excess of 50 per cent of the overall portfolio, the data from PRIME Database shows. 

Nippon India MF, Franklin Templeton, HDFC Mutual Fund, and ICICI Prudential MF are some of the other fund houses that may be considered foreign-controlled or owned under FEMA.

The rules could put these funds at a significant disadvantage vis-a-vis domestic funds, limiting their investments in stocks with sectoral caps and dragging down overall returns, said experts. 

The restrictions may also make it difficult for their exchange-traded funds to invest as per the assigned weightage of the underlying benchmarks, and put the brakes on fresh money coming into their fund of fund schemes, which invest in other mutual fund schemes.