Smrithi Punnoose
December 11, 2013
The QFI scheme – You blink and it’s gone!
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The Indian Government (“Government”) has consistently been trying to introduce schemes and routes to bring in foreign investment to an ever depleting economy, where the need for foreign exchange is only increasing. Since access to foreign institutional investment opportunities in India was by and large limited to foreign institutional investors (“FII”) and foreign venture capital investors, a new and less cumbersome regulatory framework was sought to be established by the Government.

One such scheme saw its birth in August 2011 in the form of a circular issued by the Reserve Bank of India (“RBI”). The scheme was christened the qualified foreign investor scheme and the protagonists went by the name of qualified foreign investors (“QFIs”). This route permitted foreign individuals and corporations to invest in a portfolio of Indian stocks without specific registration with the Securities Exchange Board of India (“SEBI”). A QFI is an individual, group or association, resident in a foreign country that is compliant with Financial Action Task Force (“FATF”) standards and is a signatory to the International Organization of Securities Commission’s Multilateral Memorandum of Understanding. As per the 2011 circular QFIs were first allowed to invest only in equity schemes of domestic mutual funds as well as infrastructure debt schemes. Subsequently, with the Government aiming to attract more foreign funds, and reduce market volatility, QFIs were permitted to directly invest in the Indian equity market via a circular issued by the RBI in January 2012. A number of checks and balances were also introduced in terms of the limits of investment such as a maximum ceiling of USD 10 billion in debt schemes of mutual funds. Further, QFIs could only invest through the SEBI registered qualified depository participants (“DPs”) who had to ensure that applicable KYC requirements were met.

Despite the flourish with which the scheme was introduced, the incoming fund flows did not reflect the desired outcome as envisaged by the Government. To give further impetus to foreign investors, the RBI and SEBI issued a number of circulars in July 2012 to allow QFIs to invest in the Indian corporate bond market for the first time. Norms related to the procedural mechanism for incoming foreign investments were also eased. For example, QFI’s were permitted to invest in certain eligible debt securities without a lock-in period or a residual maturity clause. Further, QFIs were also permitted to open a bank account in India in their own name, thus addressing the drawback of the earlier scheme where DPs had to hold fund inflows and outflows of all their QFI clients in a single rupee pool, which had its own set of logistical difficulties. The definition of the term QFI was also expanded to include residents of countries that were members of groups which themselves were compliant with the FATF standards. Thus, residents of countries which were members of groups such as the Gulf Cooperation Council and the European Commission would be eligible to invest in India as QFIs. Subsequently, the RBI allowed QFIs to protect their investments from exchange rate volatilities through the hedging mechanism and issued a circular in August 2012 to that effect. To further expand the avenues for foreign investments, the RBI in April 2013 issued a circular, permitting QFIs to invest in Government securities up to a limit of USD 25 billion and increased the ceiling of investment in corporate debt securities to USD 51 billion.

Despite the consistent introduction of positive changes in the QFI scheme, the route was struggling to attract investors, with hurdles being faced with respect to ambiguity in tax treatment of the gains. Kindly put, the tepid response received from investors was proof that the QFI scheme was not turning out to be much of a success. In October 2013, with the economy continuing its downtrend and the Government trying its best to deepen the Indian capital market and lower the current account deficit, the SEBI via a press release approved the SEBI (Foreign Portfolio Investors) Regulations, 2013. As per these regulations, the SEBI plans to club the existing FII regime, Sub-Accounts and the QFI regime into a new investor class to be termed as foreign portfolio investor (“FPI”). Further, instead of qualified depository participants, FPIs would be required to register themselves with designated depository participants, whose qualifications would be intimated by the SEBI. With no word yet on the implementation of these regulations, the fate of the QFI scheme still looks murky and overcast with uncertainty. Whether the Government will scrap this route all together and go ahead with the merger of schemes as suggested or formulate added modifications to revive interest in this route is left to be seen and one can only wait and watch until the next effort of the Government is announced.

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