The Government has recently allowed Qualified Foreign Investors (QFIs) to invest directly in the Indian equity market. The proposed new investment route is aimed at providing the much-needed stimulus and to improve the sentiment in our market.

Currently, investing through the FII or a sub account is the only means for foreign individuals or institutions to invest in India. In August 2011, the Securities and Exchange Board of India (SEBI) had permitted QFIs to invest in mutual fund schemes, thereby providing an indirect way of making foreign investments into Indian equity markets, and that was perhaps the starting point of the current policy.

The new policy

The SEBI will henceforth grant general permission (that is, under the automatic route) to QFIs for investment similar to FIIs. The investment by QFIs would be subject to an individual investment limit of 5 per cent of the paid-up capital of the Indian company and an aggregate investment limit of 10 per cent.

How does it work?

The regulation is structured to enable the broker to act as the marketing agent and executer of the trade, while the custodial activity, job of monitoring the QFI limits, taking care of the remittances, conversion of currency, applying for the PAN for the client, ensuring KYC compliance, and so on, will rest with the qualified DP.

This would mean that the broker would have to incur large marketing costs to acquire a client and the DP would have to incur costs to set up effective systems to ensure smooth operational flows. All this implies that the cost would be ultimately passed on to the QFI in terms of a higher fee/charge/brokerage.

The fact that the SEBI states that the Qualified DP must have a Rs 50-crore paid-up capital and should be either a clearing bank or a clearing member of any clearing corporation means that only banks and a handful of large investment service houses would qualify to act as DPs.

Impetus to flows

Under the current regulations, there are stringent conditions imposed on FIIs and sub-accounts. These conditions are not applicable to QFIs. This can prompt some overseas investors to adopt this route. It will also provide a wider audience for the Indian companies to raise funds.

A close look at the regulations reveals that the individual limit of 5 per cent and the combined limit of 10 per cent of paid-up capital per stock is over and above the FII and the NRI limits that are already in force. This could mean that QFIs could now buy into stocks that were earlier blocked due to the FII or NRI limit being breached.

Subsequent SEBI regulations released a few days ago make it clear that an NRI could invest either through the NRI (PIS account) or the QFI route (Qualified Depository Participant-DP). The NRI would, therefore, have to make a choice of either route; he would probably choose the one that is less cumbersome and where transaction costs are cheaper.

QFI's investments will be taxed at the same rate as the Indian investor, which means the Qualified Depository Participant would deduct TDS at the short-term rate for these investors at the time of remitting the sales proceeds. With the QFI investments being taxed, it virtually closes the door to larger OCBs and investors who would prefer to invest through the tax-free offshore route.

When a guru of the stock market was asked about this new regulation, he said that opening just one market does not excite him too much. If the country opens up the stock market, it should do the same to the commodity and currency markets too;, only then will the QFIs be interested in parking huge sums in India.

Check volatility?

The SEBI has stated that one of the objectives of this regulation is to make the market less volatile. QFIs are not lateral thinkers; they will think and act like all investors who are driven by greed and fear. They will, thus, probably be adding to the volatility instead of reducing the same.

A significant benefit that a QFI will enjoy is that of beneficial ownership. Smaller foreign investors buying into the India story do it through an India Fund or ETF.

However, if they buy into a stock idea, viewing themselves as part-owners of a business, then the QFI route would be ideal as they would enjoy not only voting rights but would also have their interests protected by the rights accorded to minority shareholders under the Company Law and SEBI regulations. In addition, such investors typically tend to be long-term-oriented and will also benefit from the zero tax provision for long-term capital gains.

While these new guidelines may not open the flood gates of investment into our markets, it is definitely a positive development for the long term.

( The author is Vice-President at Unifi Capital. The views are personal .)

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