GIFT City route to international equities promises greater security

Only sophisticated investors should take this route; most retail investors should stick to the mutual fund route for international investing

Indian investors will soon be able to invest in international stocks via the National Stock Exchange's (NSE) subsidiary exchange in GIFT City (an international financial services centre) called NSE International Exchange. The BSE plans to offer a similar facility through its GIFT City arm called India International Exchange. Currently, Indian investors can invest in international equities via the mutual fund route. They can also invest in stocks and exchange traded funds (ETFs) through leading brokers who have tie-ups with foreign brokers, or through specialised platforms like Globalise, Vested, etc set up specifically to provide Indian investors access to foreign equities.

Open separate brokerage and demat account

Large Indian brokerages will set up subsidiaries in GIFT City and become members of the international exchanges set up by NSE and BSE. For their existing clients, they would already have done the KYC (know your customer). Now, they will just need to take their clients’ consent for dealing with the new entity (the brokerage's subsidiary in GIFT City).

Clients will have to buy dollars from their banks and transfer it to their brokerage account in GIFT City under the liberalised remittance scheme (LRS), which has an annual limit of $250,000, to purchase stocks. The bank will check whether the client has headroom to invest further or has exhausted his LRS limit for the financial year.

Besides a brokerage account, clients will also have to open a demat account in GIFT City. NSDL and CDSL are currently in the process of setting up subsidiaries in GIFT City for this purpose.

Invest via the depository receipt route

Indian investors taking this route will not invest directly in international stocks. Instead, they will invest in depository receipts (DRs). NSE's GIFT City arm will begin by offering DRs for the top 50 US stocks. Market makers will buy these stocks in the US and place them with a custodial bank account. The latter will create DRs against them, which the market makers will then offer to investors on the exchange in GIFT City. The market makers will offer both buy and sell quotes with appropriate spread.

This market will run during the US market hours. It will operate on T+3 basis.

Greater security

One advantage of this route will be that the DRs will be kept in the investor's own demat account, where he will be able to view the securities held against his name. Currently, when an Indian investor buys international equities through an existing Indian broker (which has a tie-up with a US broker), all the securities are held by the latter in an omnibus account. "Having the DRs in the investor's own demat account is safer. When held in the US broker's account, the risk is that if the broker goes bankrupt investors could have a difficult time retrieving their securities," says Ravi Varanasi, president and chief business development officer, NSE.

The creation of DRs will also allow for fractionalisation. One class A share of Berkshire Hathaway currently costs around $436,545. An Indian investor will not be able to buy even one share of this company owing to the LRS cap of $250,000. So, the DRs offered by NSE's GIFT City arm will represent a small fraction of a US company’s share. “Fractionalisation will allow the Indian investor to buy shares of several companies and build a diversified portfolio even with a small investment,” says Varanasi. He explains that they could have chosen to offer direct stocks instead of DRs. But doing so would have meant that fractionalisation would have to be done by the brokers. The exchange preferred to do so itself, rather than leave it to brokers, so as not to give rise to any regulatory concerns.

Costs are a major issue investors face when investing in direct equities internationally. While the cost of transaction itself may not be high, other costs associated with purchasing foreign stocks, such as remittance fee and foreign exchange markup, can cause a severe dent to the investor's pocket. "We are working with a few banks to bring these costs down significantly," says Varanasi.

What should you do?

Portfolios of most Indian investors have a heavy home bias. On the other hand, most sophisticated investors abroad diversify their portfolios globally. Even Indian investors need to do the same. "The Indian market accounts for barely 3-4 per cent of global market capitalisation. Indian investors will have to invest in international equities if they want access to the balance 96-97 per cent market cap," says Pratik Oswal, head-passive funds, Motilal Oswal Asset Management Company. Above all, he adds, Indian investors should invest in a market like the US to get access to an asset class that has a low correlation with the Indian market as doing so lowers portfolio volatility. Investing in a market like the US also gives investors exposure to dollar-denominated assets, thereby providing a hedge against the Indian rupee's tendency to depreciate against the dollar.

Financial planners believe most retail investors will be better off taking the mutual fund route for international exposure, at least in the earlier years of their investment journey. "A mutual fund will give investors the benefit of diversification. If they invest in an active fund, they will get the benefit of professional fund management. Most retail investors may not have the ability to evaluate foreign stocks. And if they invest in an index fund, they will get the benefit of low cost," says Vishal Dhawan, chief financial planner, Plan Ahead Wealth Advisers. Mutual funds, according to him, also offer operational simplicity. If at all retail investors take the direct route, he adds, they should stick to exchange traded funds (ETFs) rather than individual stocks.

Those investing directly should also adopt a buy-and-hold strategy. As mentioned earlier, costs like remittance fee, forex markup, etc raise the cost of international investing considerably, especially when the amount being invested is small. "If investors engage in trading, the high costs will have a negative impact on their performance," says Dhawan. Investing systematically to average out costs also becomes a difficult proposition due to these costs.

DRs will be treated as international assets. "These assets will have to be reported as foreign assets at the time of filing income-tax returns," says Dhawan. In the case of international funds offered by domestic fund houses, no extra compliance is required at the time of filing tax returns. The only difference is that these funds get treated as debt funds for tax purposes.

Finally, only investors who have built well diversified portfolios via the mutual fund route should consider investing in foreign equities directly. They should only take this route if they have the time and the ability to evaluate stocks, instead of blindly chasing brand names they are familiar with. Also remember that many frontline US stocks have run up considerably and may not offer margin of safety, at least in the short run.

Once NSE’s GIFT City platform announces its cost structure, investors will be in a better position to decide whether they should take this route. 

How investments in equities on NSE’s Gift City platform will be taxed

• Indian residents will have to adhere to the Liberalized Remittance Scheme (LRS) limit of cumulative annual remittance of $250,000
• Long-term capital gains will suffer tax @ 10% under Section 112A of the I-T Act on the amount of capital gain exceeding Rs 1,00,000
• Short-term capital gains derived from any listed security on NSE GIFT City Platform will suffer tax @ 15% under Section 111A
• Investments in IFSC are exempted from the levy of securities transaction tax (STT)
• The concessional rate of tax under Section 112A and 111A, as mentioned above, will still apply even though the transaction is not subject to STT
• As for capital losses, the tax treatment will be the same as applicable to non-IFSC units
• Long-term capital losses will be only set off against long-term capital gains, while short-term capital losses will be set off both against short-term and long-term capital gain
• Dividend income will be subject to tax in the hands of the shareholder at the applicable slab rates

Source: RSM India