India: FDI In Non-Banking Finance Companies: Relaxation And Its Impact For Fund Managers

Last Updated: 3 October 2016
Article by Funds Team

The Reserve Bank of India (RBI) on 9 September 2016 released a notification amending the Foreign Exchange Management (Transfer and Issue of Securities to Persons Resident Outside India) Regulations, 2000 (TISPRO), as a measure to further relax foreign investments in the 'non-banking financial services' sector (Notification). This Notification operationalises the policy which was announced to the cabinet committee which cleared the decks for this liberalisation vide its press release dated 10 August 2016.

The two key relaxations sought to be introduced vide this Notification are: firstly, opening up of all the sub-sectors falling within the non-banking financial services sector for up to 100% foreign participation (either through the automatic route or the approval route); and secondly, removing any form of additional capitalisation norms linked to foreign ownership prescribed under the FDI Policy, thereby aligning the capitalisation norms with those prescribed by the relevant regulators regulating these activities.


Prior to this Notification, FDI in the non-banking finance companies (NBFC) was permitted under the automatic route in only eighteen identified sub-sectors. Further, any foreign investment in entities falling within these sub-sectors also attracted minimum capitalisation norms, as follows:

  1. USD 500,000 for foreign capital up to 51%;
  2. USD 5,000,000 for foreign capital more than 51% and up to 75%; and
  3. USD 50,000,000 for foreign capital more than 75%

The above capitalisation norms also apply to each downstream subsidiary engaging in NBFC activities, except where its parent entity already has more than 75% foreign investment..

Further, if the activity being carried out was 'non-fund based' then irrespective of the level of foreign investment, capitalisation was capped at USD 500,000. Following activities were treated as non-fund based activities:

  1. Investment advisory services;
  2. Financial consultancy;
  3. For-ex broking;
  4. Money changing business; and
  5. Credit rating agencies.

Challenges under the extant framework for fund managers

The extant framework posed the following challenges for fund managers (including those managing private equity or venture capital funds):

  1. Asset management activity, even though technically a fee based activity, was treated as a 'fund-based' activity for the purpose of capitalisation, thereby attracting prohibitively high capitalisation norms linked to foreign ownership.
  2. Since the list of permitted activities under the current list did not specifically include 'investment activities', some regulatory ambiguity existed for asset managers in terms of investing their own capital, whether as a sponsor or otherwise, in funds since it could be viewed as restricted activity requiring Foreign Investment Promotion Board (FIPB) approval.
  3. Whenever a majority foreign-owned asset management entity created a step down joint venture or a subsidiary, it attracted additional capitalisation requirements. This additional capital would have to be brought in through fresh infusion in the parent, thereby further disturbing the foreign investment at the parent entity level.

The new framework

The Notification which amends the Schedule 1 of TISPRO (and replaces the Para F.8 of Annexure B, Schedule I) which listed the erstwhile activities falling within the automatic route, now provides for foreign investment to be permitted up to 100% under the automatic route for all financial service activities which are regulated by financial sector regulators, including, the Reserve bank of India, the Securities and Exchange Board of India, the Insurance Regulatory and Development Authority, the Pension Fund Regulatory and Development Authority, the National Housing Bank or any other financial sector regulator (Financial Sector Regulator) as may be notified by the Government of India.

Further, the Notification sets out following conditions which shall apply to foreign investment in the financial services sector:

  1. Foreign investment will be subject to 'conditionalities', including minimum capitalization norms, as specified by the concerned Regulator/Government Agency.
  2. The financial service activities need to be regulated by one of the Financial Sector Regulators. Those activities which are not regulated by any Financial Sector Regulator or where only part of the financial services activity is regulated, or where there is doubt regarding the regulatory oversight, foreign investment up to 100% will be allowed under Government approval route. The government may prescribe such conditions including minimum capitalization requirement, as may be decided from time to time.
  3. Any financial services activity which is specifically regulated by any particular statute, the foreign investment limits will be restricted to those levels/limits prescribed under that statute.
  4. Downstream investments by any of these entities will be subject to the relevant sectoral regulations.

Impact of this change on fund managers

Subject to certain clarity that may still be needed, especially with respect to Alternate Investment Fund (AIF) managers (as expounded in the subsequent paragraphs), the significant impact of this Notification on fund managers is set out below:

  1. Asset management activities which are regulated by any Financial Sector Regulator should not be subject to the minimum capitalisation norms linked to foreign ownership (unless specifically required by the relevant Financial Sector Regulator), thereby significantly reducing the financial burden associated with such capitalisation. This would come as a significant relief not only for established or institutional offshore fund managers but also for smaller and start up fund managers in India who are looking to partner with offshore fund managers or give certain stake to offshore limited partners/investors.
  2. Fund managers who also act as sponsors for AIFs would not require any approval from FIPB to invest in their own funds, eliminating the ambiguity existing on the subject. While several fund managers have taken a position that their contribution into the fund is incidental to their asset management activity and hence not to be treated as a separate 'investment activity', thereby continuing to avail of the automatic route prescribed for asset management activities; there have been instances where such managers have been advised to approach FIPB for such investments and FIPB has, on a case to case basis, granted approvals. Hopefully, the new amendment should remove this ambiguity.
  3. Several institutional fund managers have created holding companies for carrying out asset management for different strategies through separate joint ventures. Each of those downstream joint ventures attracted separate capitalisation as prescribed under the extant FDI policy. With this change, the capitalisation for each activity, if any, shall be governed only be the relevant Financial Sector Regulator (instead of the FDI policy), and to the extent there is no prescribed capitalisation no additional foreign capital should be required to be brought in.

Some interpretational issues that need clarity

  1. There seems to be a lack of clarity amongst the industry players and advisors as to whether the financial services activity needs to be 'regulated', or whether the entity needs to be licensed by a regulator for it to avail the automatic route. For e.g. an AIF manager is regulated by SEBI under the SEBI (Alternative Investment Funds) Regulations, 2012 even though the entity is not licensed by SEBI.


    Clearly from a very technical reading of the Notification, the requirement of an entity in the non-banking financial services space is that the activities of the entity should be 'regulated' by a Financial Sector Regulator. The Notification does not specify the requirement of the entity being registered or licensed by a Financial Sector Regulator; and hence, we believe that the emphasis has to be on the entity being regulated rather than licensed. Clearly, in case of AIF managers, the SEBI regulations governing AIFs are fairly exhaustive in terms of the nature of obligations and duties and responsibilities and the fact that an AIF manager is subjected to SEBI regulations should be sufficient for the entity to qualify for the purpose of this Notification.
  2. Further, there is lack of clarity as to whether the above conditions could be seen as 'FDI-linked performance conditions', thereby making LLPs engaged in financial services ineligible for receiving FDI. It is not clear if an AIF manager incorporated as an LLP cannot have any foreign investment.


    The 'conditionalities' listed under the Notification are not in the nature of FDI-linked performance conditions as under the extant FDI policy. The conditionality prescribing that an entity needs to be regulated by a Financial Sector Regulator, should not be equated to conditions related to capitalisation as under the extant FDI policy. Accordingly, it appears that there should be no prohibition on LLPs engaged in the non-banking financial services sector from accepting foreign investment. Needless to say, the ownership and control of the LLP would need to be determined in case of such an LLP in accordance with the general principles and conditions laid down under the FDI Policy.


The liberalisation of FDI in the financial services sector is certainly a welcome move, and is expected to provide a much needed boost to the sector. This move is expected to particularly benefit domestic fund management and advisory businesses which may now raise foreign capital under a relaxed regime, without adhering to the previously prescribed minimum capitalisation norms. The new norms would also further the intent of the Government to encourage global fund managers to operate out of India.

We expect that the lack of clarity as to whether the relevant financial services activity needs to be 'regulated', or whether the entity needs to be 'licensed' by a regulator, for it to avail of the automatic route for FDI should be only a temporary teething issue and should be clarified in due course.

The content of this document do not necessarily reflect the views/position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up please contact Khaitan & Co at

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