The Reserve Bank of India (RBI) has released a notification to relax foreign investment requirements in the non-banking financial services sector, as the government of Narendra Modi continues on a programme to attract more international investment in the Indian economy. This notification, which has taken effect, amends the Foreign Exchange Management (Transfer and Issue of Securities to Persons Resident Outside India) Regulations, 2000 (TISPRO).
Two significant changes in the notification open up all sub-sectors within the non-banking financial services sector for up to 100% foreign participation and the removal of any form of additional capitalisation requirements linked to foreign ownership.
Previously, overseas institutions and individuals had to overcome considerable legal obstacles before they could invest at any level in the non-banking financial services sector. Before this notification, foreign direct investment in non-banking finance companies under the automatic route was limited to 18 sub-sectors and investment entities had to meet minimum capitalisation norms ranging from $500,000 to $50 million depending on the level of foreign investment. Downstream subsidiaries involved in non-banking finance companies activities also had to meet the capitalisation norms, except where the parent entity already has more than 75% foreign investment. Additionally, non-fund based activities such as investment advisory service, financial consultancy, for-ex broking, money changing business and credit rating agencies had a capitalisation of $500,000, regardless of the level of foreign investment. “Even if the business did not require capitalisation, it had to bring in a minimum cap,” says Siddharth Shah, partner in the funds practice of Khaitan & Co.
As the list of permitted activities did not specify investment activities, asset managers encountered regulatory ambiguity for funds since they could be regarded as restricted activity requiring Foreign Investment Promotion Board (FIPB) approval. Asset management activity was also treated as fund-based and had to meet the high capitalisation norms. Furthermore, when a foreign-owned asset management entity created a step down joint venture or subsidiary, it attracted additional capitalisation requirements.
Under the new framework, asset management activities regulated by a financial sector regulator would be subject to conditions that may include minimum capitalisation norms. Financial services activities have to be regulated by one of the country’s financial regulators, including the RBI, the Securities and Exchange Board of India, the Insurance Regulatory and Development Authority and National Housing Bank. Where there is doubt about whether an activity is regulated or if only part of the activity is regulated, the investment may be allowed under a government approval route. A financial services activity with a particular statute regulating it would have the same conditions applied in cases of foreign investments. If fund managers create holding companies to carry out asset management, these downstream joint ventures would not have further minimum capitalisation norms if none are required by the financial sector regulator.
“With no minimum prescribed, the same conditions would apply for foreign entities, so it takes away the disparity between domestic and foreign investments,” says Shah. “As long as the activity is regulated, it is open to foreign investment.”
However, there is still some confusion around the notification. For example, an alternative investment fund is regulated by the Securities and Exchange Board of India under the SEBI (Alternative Investment Funds) Regulations, 2012 though the entity is not licensed by the SEBI. “Certain activities are not licensed but still are regulated by a financial sector regulator, so whether they can benefit or has the policy made them more restrictive is still a grey area,” says Shah. “For holding companies that may or may not be licensed, it is not clear whether there is automatic approval or if FIPB approval is needed. But this should get ironed out and there is a dialogue going on with the government to look at the intent and spirit of the liberalisation.”
Domestic fund managers welcome the RBI’s relaxation on foreign direct investment in the non-banking financial sector. While a few details still need to be clarified, the move is an important part of the government of India’s aim to attract more global fund managers to India and to further strengthen India as the hotspot for foreign investors.