Article. FDI in financial services sector:

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1 FDI in financial services sector: Anita Baid Senior Manager Financial Services Division 30 th April, 2018 Check at: Copyright: This write up is the property of Vinod Kothari Consultants P. Ltd and no part of it can be copied, reproduced or distributed in any manner. Disclaimer: This write up is intended to initiate academic debate on a pertinent question. It is not intended to be a professional advice and should not be relied upon for real life facts.

2 Foreign Direct Investment (FDI) has always been an important source of funding for companies in our country, where capital requirement is a basic necessity for the entities. Under FDI, money from overseas, either by an individual or entity, is invested in an Indian company. In India, foreign direct investment policy is regulated under the Foreign Exchange Management Act, 2000 governed by the Reserve Bank of India (RBI). Investments are made either under automatic route which does not require approval from RBI or under government route, which requires prior approval from the concerned ministries/departments. Indian financial services sector comprises of various sub sectors like banks, non-banking financial companies (NBFCs), insurance sector entities and capital market related entities like stock and commodity exchanges, brokers, mutual funds, merchant bankers etc. The regulation and supervision of the financial services sector is carried out by various regulatory authorities. The Reserve Bank of India (RBI) regulates majority components of the financial system particularly the banking and NBFC sector. The capital markets, mutual funds and other capital market intermediaries are regulated by the Securities and Exchange Board of India (SEBI) and the insurance sector is regulated by the Insurance Regulatory and In all such financial services activity 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% is allowed under Government approval route subject to conditions including Development Authority (IRDA). However, there are certain other financial services that are carried out by such entities that not regulated by any financial sector regulator, that is to say, they are not registered with any of the regulatory authorities. The said unregulated financial services have been broadly categorized into segments, namely, fund based and non-fund based activities. Fund-based activities include: Merchant Banking Underwriting Portfolio Management Services Stock Broking Asset Management Venture Capital Custodian Services Factoring Leasing and Finance Housing Finance Credit Card Business Micro Credit Rural Credit Non-fund based activities include: Investment advisory services Financial consultancy Forex broking Money changing business Credit rating agencies

3 FDI Policy 2016 As per the Foreign Direct Investment Policy, 2016 (FDI Policy 2016), the minimum foreign capital requirement for non-fund based activities and fund based activities was as follows: 1 Non-fund based activities Minimum foreign capital requirement- USD 0.5 million To be infused upfront Fund based activities Minimum foreign capital requirement- USD 0.5 million 51 percent of this USD 0.5 million- to be infused upfront To acquire more that 51 percent stake, the minimum foreign capital requirement was USD 5 million, of which 75 percent had to be infused at once. A more than 75 percent stake could only be acquired via a joint venture with a minimum capital requirement of USD 50 million, of which USD 7.5 million will have to be infused upfront. FDI Policy, 2017 The Foreign Direct Investment Policy, , ( FDI Policy ) allows 100% FDI under automatic route in financial services activities regulated by financial sector regulators, viz., RBI, SEBI, IRDA, PFRDA, NHB or any other financial sector regulator as may be notified by the Government of India. Further, the policy allows foreign investment of up to 100% under the government approval route for financial services activities which are not regulated, or partially regulated. Earlier, it was mentioned that the same is subject to minimum capitalisation requirements, however, the policy did not specify the requirements. Accordingly, the financial services activities regulated by financial sector regulators are allowed 100% FDI under automatic route, this includes investing companies registered as NBFCs with RBI. However, foreign investment in investment companies that are not regulated by RBI and in Core Investment Companies (CICs), both engaged in the activity of investing in the capital of other Indian entities, requires prior Government approval Our detailed article on the subject can be read here-

4 Minimum Capitalisation Pursuant to the press release dated 16 th April, , the minimum capital requirements has been specified for Other Financial Services activities which are unregulated by any financial sector regulator or partially regulated or have doubts regarding regulatory oversight and FDI is allowed under government route. Consequently, companies in these categories may be required to infuse more capital than required earlier. The minimum capitalization requirement is as follows: Minimum FDI capital - USD 20 million Unregistered/ unregulated/ exempted entities engaged in 'fund based activities' Fund based activities: Merchant Banking, Under Writing, Portfolio Management Services, Stock Broking, Asset Management, Venture Capital, Custodian Services, Factoring, Leasing & Finance, Housing Finance, Credit Card Business, Micro Credit, Rural Credit Minimum FDI capital - USD 2 million Unregistered/ unregulated/ exempted entities engaged in non-fund based activities Non-fund based activities: Investment advisory services, Financial Consultancy, Forex Broking, Money Changing Business, Credit Rating Agencies. In accordance with the circular issued by the finance ministry, the new requirements would be applicable for activities which are partially regulated or have doubts regarding regulatory oversight. Some of the entities that would be impacted with this requirement includes, but are not limited to the following: 1. Portfolio management services, which manage accounts of some offshore entities, but are not currently regulated. 2. Foreign private equity funds which have set up Indian investment advisory arms, since the minimum capitalisation is of USD 2 million in unregulated Investment Advisory Services 3. Investment advisory services provided to non-residents, and are not registered with SEBI, would need to bring USD 2 million as capital as compared to USD 0.5 million in the FDI Policy Foreign-owned managers of Indian alternative investment funds, which are not directly registered with SEBI, where the capital requirement will now be USD 20 million. 4

5 Though the RBI has not yet issued any detailed guidance in the form of notification/ circular, the aforesaid press release has created a lot of challenges, for otherwise exempt/ unregulated entities in the financial services sector. Also, a clarification whether entities already set up under the old regulations with USD 0.5 million capitalisation are grandfathered or not, is awaited.