Small foreign stakes in listed cos face banks' regulatory barriers

Mumbai: Foreign investors planning to test the waters by buying small stakes through off-market deals in listed Indian companies are hitting a wall with banks throwing the rule book at them.

At least half a dozen large private and MNC banks, following a rigid interpretation of the law, have told such offshore investors that they can hold less than 10% in listed companies only after registering themselves as foreign portfolio investors (FPI) with the Securities & Exchange Board of India (Sebi).

Banks taking such a stance have blocked a few inbound investments even though the proposed share purchases were not on the stock exchange, but planned as secondary off-market trades and preferential allotment.

This stems from the understanding that foreign holdings above 10% would be categorised as 'FDI' while equity interests of less than 10% would be treated as 'foreign portfolio investment'.

"This issue has been coming up in multiple deals recently at the time of investment. FDI and FPI are two separate investment routes. Quantum of investment, in my view, should not force an investor to change the category of investment as that would not be supported by the current structure and commercial objective," said Moin Ladha, partner at the law firm Khaitan & Co.

Hesitant to commit large stakes, many (non-FPI) investors prefer single-digit holdings in listed entities.

In this context, several banks hold the view that investments classified as foreign portfolio investments could be only made by Sebi recognised FPIs. Since banks are the authorised foreign exchange dealers responsible for processing the inflows, their disapproval would either stall a transaction or drive the investor to find a bank with a more realistic interpretation of the regulations.

Agencies

Banks comfortable with less than 10% investments by non-FPI foreign investors believe that while such an investment should be classified as foreign portfolio investment, it's not necessary that the investor must be an FPI. So, any foreign investor-irrespective of whether it has an FPI license or not-can buy the shares. These banks think that the FDI-related paperwork, like filing of 'foreign currency gross provisional return' (FC-GPR), will not be necessary for such portfolio investments.

The Foreign Exchange Management (Non-debt Instruments, or NDI)) Rules state that investment of 10% or more in a listed company would be treated as FDI. "Conversely, an investment of less than 10% by any person resident outside India is treated as foreign portfolio investment under Rule 2(t). It may be noted that this is foreign portfolio investment and is applicable for any person resident outside India. It is different from a 'Foreign Portfolio Investor' which is registered with Sebi," said Anup P. Shah of PPS & Co, a tax and legal advisory firm.

"It is possible to take the view that a foreign person should be allowed to invest less than 10% in a listed company even if he is not a Sebi-registered FPI. However, this is an issue on which there is no express clarity, leading to diverse interpretations," said Shah.

Less than 10% investment, said Ladha, can be undertaken under Schedule I of the NDI rules. "The original intent of the rules is to ease reporting and not curtail investment below 10% under Schedule I," he said.

The developments take place at a point when Sebi has broached the idea of allowing foreigners to directly buy listed stocks-the way NRIs can, albeit subject to a cap.

The FDI-FPI norms are often shaped by the respective turfs of RBI (dealing with FDI) and Sebi (formulating rules on FPIs). Their inability to bridge the gaps have made the rules less flexible. For instance, an FPI must hold less than 10% in a listed company; but if it buys more shares and the holding crosses 10% to reach, say 12%, the entire 12% is considered as FDI. And, even after the FPI sells the additional shares and brings the stake below 10%, it is still considered as FDI.