India: Investment Into India - QFIs Route Via Cyprus

Last Updated: 16 October 2012
Article by Charles Savva

The Indian Government has recently allowed Qualified Foreign Investors (QFIs) to invest directly in the Indian equity market. The proposed new investment route is aimed at improving investor confidence in the Indian market.

On 29 May 2012 the Ministry of Finance of India issued a Press Release to clarify the situation with QFIs regarding direct investment into the Indian equity market. This initiative is expected to significantly stimulate foreign investment in India.

Investment through the QFI route was initially introduced by the Securities Exchange Board of India (SEBI) in August 2011.  SEBI had permitted QFIs to invest in mutual fund schemes, thereby provided an indirect way of making foreign investments into Indian equity markets. This decision marked the starting point of the current policy.

To broaden the class of investors, reduce market instability and to extend the Indian capital market, on 1 January 2012, the government announced a new scheme allowing the foreign individuals, foreign pension funds, and foreign trusts (QFIs) to invest directly in the Indian equity market.

Even though the above changes marked the opening of a completely new route for foreign investors, allowing real direct access to listed Indian equities, avoiding the requirement of registration with the SEBI or Reserve Bank of India (RBI), the route did not take off as anticipated, due to lack of clarity on various specific aspects. 

The May 2012 Press Release of the Ministry of Finance finally clarifies all uncertainties and opens a new route for foreign investors interested in investing in India. 

The details of the Press Release are as follows:

  1. Widening of QFI Compliant Jurisdiction – Cyprus being an eligible jurisdiction under the QFI route.

    Before May 2012, there was considerable uncertainty with regards to the origin (jurisdiction) of entities which would be eligible to qualify as a QFI.  For a resident of a particular jurisdiction to qualify as a QFI, the country was required to be a signatory to the International Organization of Securities Commission's (IOSCO's) Multilateral Memorandum of Understanding and be compliant with the Financial Action Task Force (FATF) standards.
    SEBI's view was that only the 34 FATF member states would be considered as compliant with FATF standards for the purposes of the QFI classification. This position raised a debate as many jurisdictions which are compliant with the FATF standards, are not its direct member. This position considerably limited the use of the route for many possible investors from non-member jurisdictions. The European Commission (EC) and the Gulf Cooperation Council (GCC) as a body are members of FATF but not every country which is member of the EC and GCC in its individual capacity is an FATF member. It wasn't clearly stated, whether the member countries of such bodies would satisfy the QFI requirement in accordance with the regulatory view.
    With issue of the said Press Release, The Indian Authorities have clarified that the residents of the 6 member countries of the GCC and the 27 member countries of the EC would be eligible to be considered as QFIs.  This provision widens the QFI route incorporating within its folds a number of important jurisdictions, including Cyprus which has among the most favorable double tax treaty with India and is now an eligible jurisdiction under the QFI route.  It should be note that Mauritius will remain out of the scope from a QFI perspective.
  2. QFI investment in corporate bonds.

    A budget proposal for QFIs is being introduced, allowing QFIs to invest in corporate bonds and mutual fund debt schemes.  A separate sublimit of USD 1 billion has been also created for the purposes of QFI investment in such corporate bonds and mutual fund debt schemes.
    This provision may positively influence foreign inflows, primarily with regards to foreign investors interested in debt investments, for example  high net worth individuals (HNIs) who are enticed by the high level of interest rates and returns that debt investments offer.  The QFI route shall provide a direct alternative to the foreign investors who were previously forced to invest in non – convertible debentures listed on the stock exchange through the foreign institutional investments route.  The Press Release doesn't clarify however, whether QFIs would be allowed to invest in unlisted corporate bonds.
    NOTE: This issue was further clarified by the RBI circulars.
  3. Removal of 5 day limit.

    Previously if the funds of QFI were not invested within five working days of the receipt of the funds, and simply remitted in the Indian rupee account of the QFI, they were required to be transferred to the designated overseas bank account of the QFI.  This rule caused many administrative inconveniences and loss, due to the exchange rate fluctuations.

    According to the Press Release, The Ministry has now decided to remove the 5 day limit rule, allowing the QFI to have the freedom to retain the funds in their account in India, reducing the high cost of transfer of funds and other losses, for example due to the exchange rate. 
  4. Freedom to open a separate account.

    Before May 2012, the QFIs were allowed to invest only through the rupee pool bank account of their Qualified Depository Participant (QDP). The Press Release now permits QFIs to open a separate individual non-interest bearing rupee bank account with authorized dealer banks in India to undertake transactions under this route. 
  5. Implementation of the changes.

    Lastly, the Press Release requires the regulators i.e. SEBI and RBI as well as the Central Board of Direct Taxes to issue relevant circulars to incorporate and implement the changes.  The circulars of SEBI were issued on the following dates: 7 June, 18 July and 20 July 2012. The circular of RBI was issued on 16 July 2012.

According to the circulars the QFIs are permitted to invest, in addition to the units of mutual funds and shares of listed Indian companies, in the following debt securities:

  1. Listed and to be listed non-convertible bonds (NCDs);
  2. Listed and to be listed bonds of Indian companies; and
  3. Listed units of mutual fund debt schemes. 

Other important amendments of the circulars include clarification of:

  1. Eligible instruments and transactions;
  2. Allocation of the Debt Limits;
  3. Hedging;
  4. Definition of QFIs.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Charles Savva
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