by Puneet Shah.Financial sector reforms have always impacted the common Indian citizen given the growing linkage of Indian economy with the world at large. Today, we live in a global village with strong and growing inter-dependence between our financial systems and the global economies. India’s financial sector has diversified and expanded significantly over the last couple of years. It currently comprises of institutions such as commercial and co-operative banks, non-banking finance companies (NBFC), insurance companies, pension funds, mutual funds, alternative investment and venture capital funds (AIF) and other similar financing entities and pooling vehicles..Continuing with its commitment towards liberalising the existing foreign direct investment regime in India, the Government last month introduced some important policy amendments relating to FDI in financial services sector..As per the prevailing FDI regulations, FDI was allowed under the automatic route in only 18 specified NBFC activities with their sub-categorisation into fund based and non-fund based NBFC activities. FDI in non-fund based NBFC activities such as investment advisory, financial consulting, forex broking, money changing and credit rating was subject to a minimum FDI investment threshold (commonly known as minimum capitalisation norms) of USD 0.5 million by the FDI investor..FDI in fund based NBFC activities such as asset management, merchant banking, under-writing, portfolio management, stock-broking, housing finance and venture capital, to name a few, was subject to minimum capitalisation ranging from USD 0.5 million to USD 50 million depending on the share ownership percentage of the FDI investor in the NBFC entity. FDI investment in any other financial service activity (other than those 18 specified NBFC activities) was subject to prior Government approval..By way of an amendment notification [pdf] issued last month, the Government has amended FDI regulations to allow FDI in other financial services beyond the 18 specified NBFC activities in the automatic route provided these activities are regulated by any financial sector regulator namely RBI, SEBI, IRDA, PFRDA, NHB or any other financial sector regulator..The amendment notification has also put an end to the minimum capitalization requirement for FDI investment in NBFC activities considering that the relevant financial sector regulator which regulates these activities prescribe their own set of capitalization, net-worth and capital commitment norms for the entity. In all other financial services activity, which are either 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, subject to conditions including minimum capitalization requirement, as may be decided by the Government while granting the FDI approval..The recent amendments ushering liberalisation provided much needed clarity on the legal validity of FDI investment in unspecified NBFC activities which until now were subject matter of interpretation. On the other hand, the amendments have also provided significant relief to foreign investors in terms of complying with minimum capitalisation norms. This was proving to be an obstacle in the potential growth of the financial service sector as some of the NBFC activities (such as portfolio management, venture capital fund, stock broking) which require much lesser capitalisation compared to those prescribed in the hitherto prevailing FDI regulations..Also, NBFCs which are purely engaged in the asset management and advisory business or entities operating the stored value card business were not requiring so much capital due to their inherent business model. Eliminating the minimum capitalisation for these business activities would give much needed booster for FDI investment into these businesses..Whilst the foregoing amendments to the FDI regulations are certainly a welcome move by the Government, there are few issues which require immediate clarity from the relevant financial sector regulators..For instance, SEBI needs to clarify if the investment manager and sponsor to an AIF can construe to be regulated entities for the purpose of FDI investments. This is particularly so when the AIF investment manager and sponsor are not issued any separate registration certificate by SEBI, but are subject to the regulatory supervision of SEBI and are required to adhere to various compliances under the SEBI AIF regulations including minimum capitalisation to AIF..Similar clarification is required from SEBI in the context of a mutual fund asset management company and sponsor. It may also be worth discussing if the minimum capitalisation by a sponsor entity constituted as LLP would be construed as FDI linked performance condition thereby requiring prior approval from Government for FDI investment into such LLPs..Some of the other issues which warrants regulator’s attention post the recent liberalisation is with reference to the entities engaged in marketing and distribution of financial products such as mutual fund units, insurance policies, unit linked insurance plan etc. Presently it is not clear if these activities could be construed as regulated activities for the purpose of FDI investment since these activities directly and indirectly are subject to supervision of SEBI and IRDA and in some cases through self-regulatory organisations such as AMFI etc. Also, RBI may have to clarify if the entities engaged in operating crowdfunding and peer 2 peer lending platforms would be considered as regulated entities for the purpose of FDI investments particularly when their role in fund raising is limited to being a market aggregator and facilitator and their business is more technology driven rather than having any inherent credit or settlement risk..The growth of financial service sector in the country can be attributed to the financial inclusion of those having no or limited access to the capital for nurturing their entrepreneurial capabilities. Needless to mention that over the last couple of years, financial institutions, venture capital funds including micro finance NBFCs have played a crucial role in creating entrepreneurial culture in the country by providing much-needed growth capital to the businesses in need. Aiming ease of foreign fund raising in the financial service industry, the liberalised FDI reforms proposed by the Government have the potential to ensure financial inclusion of economically weaker section of the society..The government’s stable and transparent policies coupled with improved consumer sentiments post above normal monsoon has given bright prospects to transform Indian economy into an engine of rapid economic growth. The foregoing amendments into FDI regulation are steps in the same direction..Author is a principal associate with law firm – IC Legal based in Mumbai. Views are personal.
