CHAPTER 1
CAPITAL MARKET- AN OVERVIEW
1.1 Introduction to Capital Market:
A capital market can be defined as “The market for long-term funds where securities
such as common stock, preferred stock, and bonds are traded”. Both the primary
market for new issues and the secondary market for existing securities are part of the
capital market. The capital market is an important part of financial system. Capital
market can be defined as “A market for long term funds both equity and debt and
funds raised within and outside the country.” In other words capital market is wide
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term used to comprise all operations in the new issues and stock market. New issues
made by companies constitute the primary market, while trading in existing securities
comprise secondary market. In simple words capital market encompasses all the
activities of F.I.s, Banks, NBFCs, etc, at a long term perspective or for a period more
than one year. The capital market aids economic growth by mobilizing savings of the
economic sectors and directing the same towards channels of productive use. This is
facilitated through the following measures.
iIssue of ‘primary securities’ in the ‘primary market’, i.e., directing cash flow from
the surplus sector to the deficit sectors such as the government and the corporate
sector.
iiIssue of ‘secondary securities’ in the ‘primary market’ i.e., directing cash flow
from the surplus sector to financial intermediaries such as banking as non-banking
financial institutions.
iiiSecondary market transactions in outstanding securities which facilitated liquidity.
The liquidity of the stock market is an important factor affecting growth. Many
profitable projects require long term financial investment which was locking up funds
for a long period. Investors do not like to relinquish control over their savings for such
a long time.
Hence they are reluctant to invest in long gestation projects. It is the presences of the
liquid secondary market that attracts investors because it ensures a quick exit without
heavy losses or costs.
Hence, the development of an efficient capital market is necessary for creating a
climate conductive to investment and economic growth.
1.1.1 Major Players in the Market:
The players in the capital market can be divided into following two broad areas.
I. Players in Primary Market:
1) Merchant Banker: The functions and working of merchant bankers are very
crucial in the primary market. They act as issue managers, lead managers, co-
managers and are responsible to the company and SEBI.
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They take all policy decisions for and behalf of company regarding the new issue and
coordinate the various agencies and give “Due Diligence” certificate to the SEBI
regarding the true disclosures as required by law and SEBI guidelines.
2) Registrars: The functions of registrars in next important is merchant bankers.
They collect applications for new issues, their cheques, stock invests etc., classify and
Computerize them. They also make allotments in consultation with the regional stock
exchanges regarding norms in the event of over subscription and before a public
representative. They have to dispatch the litters of allotments, refund orders and share
certificates within the time schedules stipulated under the companies act and observe
the guidelines of SEBI, the Governments and RBI. Besides they have also to satisfy
the listing requirements and get them listed one or more stock exchanges.
3) Collecting and Co-coordinating bankers: The collecting and co-coordinating
banks may be same or different. While the former collects subscripting in cash,
cheques, stock invests etc., the later collates the information on subscriptions and co-
ordinates the collection work and monitors the same to the registrars and merchant
bankers, who in turn keep the company informed.
4) Underwriters and Brokers: Underwriters may be financial institutions, banks,
mutual funds, brokers etc, and undertake to mobilize the subscriptions up to some
limits; failing to secure subscriptions as agreed to, they have to make good the
shortfalls by their own subscriptions. Brokers along with their network of sub-brokers
market the new issues by their own circulars, sending the applications from and
follow up recommendations.
5) Printers, advertising and mailing agencies: They are other organizations
involved in the new issue market operations.
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II. Secondary Market Intermediaries: The major players in the secondary market
are issuers of securities, companies, intermediaries like brokers, sub-brokers etc., and
the investors who bring in their savings and funds into the market.
The stock brokers are of various categories, namely:
iClient Brokers: These are players doing simple broking between buyers and sellers
and earning only brokerage for their services from the clients.
iiFloor Brokers: Floor brokers are authorised clerks and sub brokers who enter the
trading floor and execute orders for the clients or for members, and also called trading
brokers.
iiiJobbers: These are those members who are ready to buy & sell simultaneously in
selected scrips, offering bid and offer rates for the brokers and sub-brokers on the
trading floor &earning profit through the margin between buying and selling rates.
This category includes market for some scrips.
ivArbitrageurs: The brokers, who do inter market deals for a profit through
differences in prices as between markets, say buy in BSE & sell in NSE and vice-
versa.
1.1.2 FUNCTIONS OF CAPITAL MARKET:
The functions of efficient stock markets are as follows.
1)Mobilise long-term savings to finance long-term investments.
2)Provide risk capital in form of equity or quasi-equity to entrepreneurs.
3)Encourage broader ownership of productive assets.
4)Provide liquidity with a mechanism enabling the investors to sell financial assets.
5) Lower the cost of transaction and information.
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6) Improve the efficiency of capital allocation through competitive pricing
mechanism.
1.1.3 Types of Capital Market:
The capital market can be broadly classified into following three types-
iPrimary Market
iiSecondary Market and
iiiDebt Market.
The various types of capital market can be explained later on in this chapter.
1.2 The Primary Market:
1.2.1 Introduction:
The primary market is market for new issues. It is also the new issues market. It is a
market for fresh capital. Funds are mobilised in the primary market through
prospectus, right issues, & private placement. Bonus issue is also one way to raise
capital but it does not bring in any fresh capital.
Some companies distribute profit of existing shareholders by the way of fully paid
bonus share instead of paying them dividend. Bonus share are issued in the ratio of
the existing share held. The shareholders do not have to pay for bonus share but the
rational earnings are converted into capital.
Thus, bonus share enable the company to restructure its capital. Bonus is the
capitalisation of free reserves. Higher the free reserves, higher are the chances of a
bonus issue forthcoming from a corporate. Bonus issue creates excitement in the
market as the shareholders do not have to pay for them and in addition, they add to
their wealth.
Companies issue bonus share for various reasons are:
i To boost liquidity to their stock:
A bonus issue results in expansion of equity base, increasing the number of absolute
share available for trading.
iiTo bring down the stock price:
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A high price often acts as a deterrent far a retail investor to buy a stock. The price of a
stock falls on becoming ex-bonus because an investor buying share ex-bonus is not
entitled to bonus share. For instance, scrip trading at`600 cum bonus with a 1:1bonus
begins trading at 300 ex-bonuses.
iiiTo restructure their capital:
Companies with high resources prefer to bonus share as the issue not only restructure
their capital but since they are perceived to be likely candidates for bonus issue by
investors. They fulfill the expectations of the investors.
1.2.2 Type of Issues in Primary Market:
Types issues in Indian Primary Market
Primarily, issues can be classified as a Public, Rights or Preferential issues (also
known as private placements). While public and rights issues involve a detailed
procedure, private placements or preferential issues are relatively simpler. The
classification of issues is illustrated below:
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Initial Public Offering (IPO) is when an unlisted company makes either a fresh issue
of securities or an offer for sale of its existing securities or both for the first time to
the public. This paves way for listing and trading of the issuer’s securities.
A follow on public offering (Further Issue) is when an already listed company makes
either afresh issue of securities to the public or an offer for sale to the public, through
an offer document.
Rights Issue is when a listed company which proposes to issue fresh securities to its
existing shareholders as on a record date. The rights are normally offered in a
particular ratio to the number of securities held prior to the issue. This route is best
suited for companies who would like to raise capital without diluting stake of its
existing shareholders.
A Preferential issue is an issue of shares or of convertible securities by listed
companies to a select group of persons under Section 81 of the Companies Act, 1956
which is neither a rights issue nor a public issue. This is a faster way for a company to
raise equity capital. The issuer company has to comply with the Companies Act and
the requirements contained in the Chapter pertaining to preferential allotment in SEBI
guidelines which inter-alia include pricing, disclosures in notice etc.
1.2.3 Offer Documents for the Primary Market:
According to SEBI “draft offer document” means the prospectus in case of a public
issue and letter of offer in case of right issue has to be filed with registrar of
companies (ROC) and notified to stock exchanges. This offer document contains
exclusive information about the companies & its activities. The offer document used
in ease of book built public issue is also called draft red hearing prospectus and
contains information that justify the pricing of the issue. This helps the investors to
rationalize their investment in the issue offered by the company. Basically, the draft
offer document implies the offer document in draft stage.
The draft offer document by the issuer company has to be filed with SEBI, at least 21
days prior to the filing of the document with ROC/ stock exchanges. On submission
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SEBI may suggest changes, if any, and the issuer or lead merchant has to make such
changes before filing the documents of the ROC/ stock exchanges. The documents are
put on the website of SEBI for 21 days from filing of the documents, for public
comment. In case of a preference issue, QIB issue or private placement, the filing of
documents with SEBI in not required. Only the merchant banker handing the issue
files the documents to the concerned stock in charge. A company aiming to have an
issue in the primary market have to complete issue in the primary market has to
complete with SEBI disclosure and investors protection (DIP) guidelines before filing
the documents with SEBI.
1.2.4 Types of Investors in Primary Market:
SEBI broadly classifies investors into following categories, SEBI FAQs (March
2008):
I. Retail Investors (RIIs):
Retail investors companies of the individual investors spread across the country.
They apply or bid for maximum security value of Rs.150000.
II. Qualified institutional Buyer (QIB):
QIBs are the financial institution like public financial institution, commercial banks;
FIIs & Provident funds those investors in the securities.
III. Non-Institutional Investors (NIIs):
NIIs are the categories of investors which do not fall in the above categories
In all book building issue SEBI has a fixed maximum limit up to which any of the
above types investors can invest, for example: QIBs portion can be 50% of the entire
amount, Riis can be 35% & NIIs can be 15%.
1.3 The Secondary Market:
1.3.1 Introduction:
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The secondary market is a market in which existing securities are resold or traded.
This market is also known as stock market. In India the secondary market consists of
recognised stock exchanges operating under the rules, by laws and regulations duly
approved by the government. These shock exchanges constitute an organized market
where securities issued by central and state governments, public bodies and joint
stock companies are traded.
According to section 2(3) of The Securities Contract (Regulation) Act, 1956 a
stock exchange is defined as a body of individuals whether
Incorporated or not, constitute for the purpose of assisting, regulating and controlling
the business of buying, selling and dealing in securities. The major stock exchanges in
the world are NASDAQ, New York Stock Exchange (NYSE), London Stock
Exchange (LSE), Dow Jones, Tokyo Stock Exchange, etc. The major stock exchanges
in India are BSE, NSE and OTCEI.
1.3.2 Development of Stock Market in India:
The origin of the Indian stock market dates way back in the 18th century when long
term negotiable securities were first issued. The real beginning however, occurred in
the middle of the 19th century after the formation of the Companies Act of 1850,
which introduced feature of limited liability and generated investor’s interest in
corporate securities. The first stock exchange in India was Native Stock Brokers’
Association which is known as the Bombay Stock Exchange. It was formed in the
year 1875. The exchange was started under Banyan Tree with only few brokers. The
development led to reforms throughout India with the development of Ahmadabad
Stock Exchange (1894), Calcutta Stock Exchange (1908), and Madras
(Chennai) Stock Exchange (1937). In order to promote orderly development of stock
exchanges the government introduced a comprehensive legislation called Securities
Contract (Regulation) Act, 1956.
The trade in the secondary market was largely dominated by the Calcutta Stock
Exchange (CSE) till 1960s. Most of the companies registered in India were mainly
listed on two major stock exchanges the CSE and the BSE. In 1961 out of the 1203
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companies listed on the Indian stock exchanges 576 were listed on the CSE and 297
were listed on the BSE. The shift of dominance from CSE to BSE started in the late
1960s. Till the early 1990s, the Indian secondary market was plagued with many
limitations such as:
1. Uncertainty of execution price.
2. Uncertainty of delivery and settlement periods.
3. Front running, trading ahead of a client on knowledge of client order.
4. Lack of transparency.
5. High transaction cost.
6. Absence of risk management.
7. Systemic failure of entire market and market closure due to scams.
8. Club mentality of brokers.
9. Kerb trading (off market deals).
In 1991 after the liberalization of the Indian economy, the stock markets entered into
an era of reforms. SEBI was established in the year 1988 but it became a regulatory
body for transaction and issuance of securities, with enation of the SEBI Act, 1992.
The Indian stock market then follows a three tier structure form. The structure has:
iRegional stock exchanges.
iiNational Stock Exchange Ltd. (NSE) and
iiiOver The Counter Exchange of India (OTCEI).
NSE was first setup in 1994 as the first automated screen based exchange in India. It
worked on the concept of order matching. The establishment of NSE is marked as a
revolution the Indian stock exchanges. After NSE all major stock exchanges started
electronic trading and dematerialization of securities became necessary for issuers.
Now with e-Revolution in India trader sitting in any part of Country can buy and sell
shares on the market platform during the trading hours. The OTCEI was established in
1992 to enable small and medium enterprises to raise funds and generate capital at
low cost.
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Chapter 2:
FOREIGN INVESTMENTS - OVERVIEW
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2.1 Introduction to foreign investments
Foreign investment refers to the investments made by the residents of a country in
the financial assets and production process of another country.
The foreign investment is necessary for all developing nation as well as developed
nation but it may differ from country to country. The developing economies are in a
most need of these foreign investments for boosting up the entire development of the
nation in productivity of the labour, machinery etc. The foreign investment or foreign
capital helps to build up the foreign exchange reserves needed to meet trade deficit or
we can say that foreign investment provides a channel through which developing
countries gain access to foreign capital which is needed most for the development of
the nations in the area of industry, telecom, agriculture, IT etc. The foreign investment
also affects on the recipient country like it affects on its factor productivity as well as
affects on balance of payments. Foreign investment can come in two forms: foreign
direct investment and foreign institutional investment.
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2.1.1 Foreign direct investment
“Foreign direct investment reflects the objective of obtaining a lasting interest by a
resident entity in one economy (“direct investor”) in an entity resident in an economy
other than that of the investor (“direct investment enterprise”). The lasting interest
implies the existence of a long-term relationship between the direct investor and a
significant degree of influence on the management of the enterprise.”
It has further two types
1) Horizontal FDI
2) Vertical FDI
Horizontal FDI:
Horizontal multinationals are firms that produce the same good or services in multiple
plants in different countries, where each plant serves the local market from the local
production. Two factors are important for the appearance of horizontal FDI: presence
of positive trade costs and firm-level scale economies. The main motivation for
horizontal FDI is to avoid transportation costs or to get access to a foreign market
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which can only be served locally. The horizontal models predict that multinational
activities can arise between similar countries.
The intuition behind horizontal FDI is best described in form of an equation with
costs on the one side and benefits on the other side. Establishing a foreign production
instead of serving the market by exports means additional costs of dealing with a new
country. Moreover, there are production costs, both fixed and variable, depending on
factor prices and technology. The plant-level economies of scales will increase the
costs of establishing foreign plants. On the other side of the equation, there are cost
savings by switching from exports to local production. The most obvious are transport
costs and tariffs. Additional benefits arise from the proximity to the market, as shorter
delivery and quicker response to the market becomes easier. Thus, if benefits
outweigh the costs a multinational enterprise will conduct a horizontal FDI.
Vertical FDI
Vertical FDI refers to those multinationals that fragment production process
geographically. It is called “vertical” because MNE separates the production chain
vertically by outsourcing some production stages abroad. The basic idea behind the
analysis of this type of FDI is that a production process consists of multiple stages
with different input requirements. If input prices vary across countries, it becomes
profitable for the firm to split the production chain.
Similar to the intuition of the horizontal models, the decision to conduct vertical FDI
can be described as a trade-off between costs and benefits. The benefits arise from the
lower production costs in the new location. The production chain consists of several
stages, often with different factors required for each stage. A difference in factor
prices makes it then profitable to shift particular stages to the countries, where this
factor is relatively cheaper. This is only profitable as long as the costs of
fragmentation are lower than the cost savings. The costs of splitting the production
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process emerge in form of transportation costs, additional costs for acting in a new
country, or of having different parts of production in different countries.
2.1.2 Foreign portfolio investments or Portfolio Investment:
Foreign portfolio investment is the entry of funds into a country where foreigners
make purchases in the country’s stock and bond markets, sometimes for speculation.
Portfolio investments typically involve transactions in securities that are highly liquid,
i.e. they can be bought and sold very quickly. A portfolio investment is an investment
made by an investor who is not involved in the management of a company. This is in
contrast to direct investment, which allows an investor to exercise a certain degree of
managerial control over a company. Equity investments where the owner holds less
than 10% of a company's shares are classified as portfolio investment. These
transactions are also referred to as "portfolio flows" and are recorded in the financial
account of a country's balance of payments. According to the Institute of International
Finance, portfolio flows arise through the transfer of ownership of securities from one
country to another.
Foreign portfolio investment is positively influenced by high rates of return and
reduction of risk through geographic diversification. The return on foreign portfolio
investment is normally in the form of interest payments or non-voting dividends.
With the ongoing globalization the role of institutional investors in foreign capital
flows has increased to a great extent. They are being regarded as kingpin of financial
globalization. But what are the possible gains from foreign institutional investments.
The developing countries like India generally have a chronic shortage of capital. The
entry of FIIs is expected to bring that much needed capital. However, as most of
purchases by FIIs are on secondary market, their direct contribution to investment
may not be very significant. Yet, FIIs contribute indirectly in a number of ways
towards increasing capital formation in the host country. Increased participation of
foreign investors increases the potentially available capital for investment and thus
lowers the cost of capital. Further, purchases of FIIs give an upward thrust to
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domestic stock prices and thus increase the price-earnings ratio of firm. Both these
factors are expected to increases overall level of investment in an economy. Thus,
FIIs can prove to be an important boost for capital formation.
Portfolio investment is also expected to improve the functioning of domestic stock
exchanges. The host country seeking foreign portfolio investment has to improve its
trading and delivery system. Also, consistent and business friendly policies have to be
followed in order to retain the confidence of foreign investors. Further, portfolio
investors are known to have highly competent financial analyst. They have access to
most advanced technology, best possible information and vast and global experience
in investment business. Due to these qualities the entry of FIIs can substantially
increase the allocative efficiency of domestic stock market.
However, increased activities of FIIs in developing countries can also have negative
impacts. Since the 1996 Mexican crises and widespread Asian crises, many
economists have questioned the wisdom of policy-makers in developing world in
discriminately inviting portfolio flows. Institutional investments are highly volatile
and even in case of small economic problem investors can destabilize the economy by
making large and concerted withdrawals. Many possible reasons have been mentioned
in literature for explaining the volatility of portfolio investment. A straight forward
reasoning follows from the fact that institutional investors actually act as agents of
principle fund owners. The later generally observe the performance of agent investors
at a short notice, often on the basis of quarterly reports. Because of this FIIs face very
short-term performance targets. So they do not afford to stick to a lose making
position even for a short period and withdraw at the first sign of trouble. Further, as
the fund owners can shift between agent investors in very short period, the later
follow the performance and activities of each other very closely.
When one agent withdraws from an economy realizing the initial sign of trouble, the
others also follow the suit. Thus, a small economic problem can be converted into an
economic disaster due to the herding behavior of FIIs.
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Another problem with portfolio investment is that it influences the domestic exchange
rate and can cause its artificial appreciation. The inflow of foreign capital raises the
demand for non-tradable goods, which results in appreciation of the real exchange
rate. With a floating exchange rate regime and no central bank invention, the
appreciation will take place through nominal rate.
The net impact of foreign institutional investment in a country therefore depends upon
the policy response of concerned authority regarding the problems posed by such
investment.
2.1.3 Investment in GDRs, ADRs, FCCBs
Foreign currency convertible bonds (FCCBs
Foreign currency convertible bonds (FCCBs) are a special category of bonds. FCCBs
are issued in currencies different from the issuing company's domestic currency.
Corporate issue FCCBs to raise money in foreign currencies. These bonds retain all
features of a convertible bond, making them very attractive to both the investors and
the issuers.
These bonds assume great importance for multinational corporations and in the
current business scenario of globalization, where companies are constantly dealing in
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foreign currencies.
FCCBs are quasi-debt instruments and tradable on the stock exchange. Investors are
hedge-fund arbitrators or foreign nationals.
FCCBs appear on the liabilities side of the issuing company's balance sheet.
Under IFRS provisions, a company must mark-to-market the amount of its
outstanding bonds.
The relevant provisions for FCCB accounting are International Accounting Standards:
IAS 39, IAS 32 and IFRS 7.
FCCB are issued by a company which can be redeemed either at maturity or at a price
assured by the issuer. In case the company fails to reach the assured price, bond issuer
is to get it redeemed. The price and the yield on the bond moves on the opposite
direction. The higher the yield, lower is the price.
Foreign currency convertible bonds are equity linked debt securities that are to be
converted into equity or depository receipts after a specified period. Thus a holder of
FCCB has the option of either converting it into equity share at a predetermined price
or exchange rate, or retaining the bonds.
American depositary receipt (ADR)
American depositary receipt (ADR) is a negotiable security that represents securities
of a non-US company that trades in the US financial markets. Securities of a foreign
company that are represented by an ADR are called American depositary shares
(ADSs).
Shares of many non-US companies trade on US stock exchanges through ADRs.
ADRs are denominated and pay dividends in US dollars and may be traded like
regular shares of stock. Over-the-counter ADRs may only trade in extended hours.
The first ADR was introduced by J.P. Morgan in 1927 for the British retailer
Selfridges.
ADRs are one type of depositary receipt (DR), which are any negotiable securities
that represent securities of companies that are foreign to the market on which the DR
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trades. DRs enable domestic investors to buy securities of foreign companies without
the accompanying risks or inconveniences of cross-border and cross-currency
transactions.
Each ADR is issued by a domestic custodian bank when the underlying shares are
deposited in a foreign depositary bank, usually by a broker who has purchased the
shares in the open market local to the foreign company. An ADR can represent a
fraction of a share, a single share, or multiple shares of a foreign security. The holder
of a DR has the right to obtain the underlying foreign security that the DR represents,
but investors usually find it more convenient to own the DR. The price of a DR
generally tracks the price of the foreign security in its home market, adjusted for the
ratio of DRs to foreign company shares.
Global depository receipt (GDR)
A Global depository receipt (GDR) also known as International depository receipt
(IDR), is a certificate issued by a depository bank, which purchases shares of foreign
companies and deposits it on the account. They are the global equivalent of the
original American Depository Receipts (ADR) on which they are based. GDRs
represent ownership of an underlying number of shares of a foreign company and are
commonly used to invest in companies from developing or emerging markets by
investors in developed markets.
Prices of global depositary receipt are based on the values of related shares, but they
are traded and settled independently of the underlying share. Typically 1 GDR is
equal to 10 underlying shares, but any ratio can be used. It is a negotiable instrument
which is denominated in some freely convertible currency. GDR enables a company
(issuer) to access investors in capital markets outside of its home country.
Several examples international banks issue GDRs, such as JPMorgan Chase,
Citigroup, Deutsche Bank, The Bank of New York Mellon. GDRs are often listed in
the Frankfurt Stock Exchange, Luxembourg Stock Exchange and in the London Stock
Exchange, where they are traded on the International Order Book (IOB).
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2.1.4 Investment by Foreign Institutional Investors (FIIs)
The Foreign Institutional Investors (FIIs) have emerged as noteworthy players in the
Indian stock market and their growing contribution adds as an important feature of the
development of stock market in India. To facilitate foreign capital flows, developing
countries have been advised to strengthen their stock market. As a result, the Indian
stock markets have reached new heights and became more volatile making the
research work in this dimension of establishing the link between FIIs and stock
market volatility. Foreign institutional investors have gained a significant role in
Indian stock markets. The dawn of 21st century has shown the real dynamism of stock
market and the various benchmarking of sensitivity index (Sensex) in terms of its
highest peaks and sudden falls.
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Chapter: 3
Foreign Institutional Investors (FII) – An overview
3.1 Foreign Institutional Investors (FII)
FIIs are contributing to the foreign exchange inflow as the funds from multilateral
finance institutions and FDI are insufficient,
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THE RECENT spat over the tax authorities issuing notices to foreign institutional
investors (FIIs) which take advantage under the Indo-Mauritius Bouble Taxation
Avoidance Agreement, has once again drawn attention to the role that FII investment
is playing in the capital markets in India. This article endeavours to place the overall
picture in perspective.
The Union Government allowed the entry of FIIs in order to encourage the capital
market and attract foreign funds to India. Today, FIIs are permitted to invest in all
securities traded on the primary and secondary markets, including equity shares and
other securities listed or to be listed on the stock exchanges. The original guidelines
were issued in September 1992. Subsequently, the Securities and Exchange Board of
India (SEBI) notified the SEBI (Foreign Institutional Investors) Regulations, 1995 in
November 1995.
Over the years, different types of FIIs have been allowed to operate in Indian stock
markets. They now include institutions such as pension funds, mutual funds,
investment trusts, asset management companies, nominee companies,
incorporated/institutional portfolio managers, university funds, endowments,
foundations and charitable trusts/societies with a track record. Proprietary funds have
also been permitted to make investments through the FII route subject to certain
conditions.
The SEBI is the nodal agency for dealing with FIIs, and they have to obtain initial
registration with SEBI. The registration fee is $10,000. For granting registration to an
FII, the SEBI takes into account the track record of the FII, its professional
competence, financial soundness, experience and such other criteria as may be
considered relevant by SEBI. Besides, FIIs seeking initial registration with SEBI will
be required to hold a registration from an appropriate foreign regulatory authority in
the country of domicile/incorporation of the FII. The broad based criteria for FII
registration has recently been relaxed. An FII is now considered as broad based if it
has at least 20 investors with no investor holding more than 10 per cent of shares/units
of the company/fund.
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The SEBI's initial registration is valid for five years. The Reserve Bank of India's
general permission to FIIs will also hold good for five years. Both will be renewable.
There are approximately 500 FIIs registered with SEBI, but not all of them are active.
The RBI, by its general permission, allows a registered FII to buy, sell and realise
capital gains on investments made through initial corpus remitted to India,
subscribe/renounce rights offerings of shares, invest in all recognised stock exchanges
through a designated bank branch and appoint domestic custodians for custody of
investments held.
FIIs can invest in all securities traded on the primary and secondary markets. Such
investments include equity/debentures/warrants/other securities/instruments of
companies unlisted, listed or to be listed on a stock exchange in India including the
Over-the-Counter Exchange of India, derivatives traded on a recognised stock
exchange and schemes floated by domestic mutual funds. A major feature of the
guidelines is that there are no restrictions on the volume of investment - minimum or
maximum - for the purpose of entry of FIIs. There is also no lock-in period prescribed
for the purpose of such investments.
Further, FIIs can repatriate capital gains, dividends, incomes received by way of
interest and any compensation received towards sale/renouncement of rights offering
of shares subject to payment of withholding tax at source. The net proceeds can be
remitted at market rates of exchange.
All secondary market operations would be only through the recognised intermediaries
on the Indian stock exchanges, including OTCEI. Forward exchange cover can be
provided to FIIs by authorised dealers both in respect of equity and debt instruments,
subject to prescribed guidelines. Further, FIIs can lend securities through an approved
intermediary in accordance with stock lending schemes of SEBI.
3.2 History of Foreign Institutional Investors (FII)
Date Policy change
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September
1992 FIIs allowed to invest by the Government Guidelines in all securities
in both primary and secondary markets and schemes floated by
mutual funds. Single FIIs to invest 5 per cent and all FIIs allowed to
invest 24 per cent of a company’s issued capital. Broad based funds
to have50 investors with no one holding more than 5 per cent.
The objective was to have reputed foreign investors, such as, pension
funds, mutual fund or investment trusts and other broad based
institutional investors in the capital market.
April 1997
Aggregated limit for all FIIs increased to 30 per cent subject to
special procedure and resolution.
The objective was to increase the participation by FIIs.
April 1998
FIIs permitted to invest in dated Government securities subject to a
ceiling. Consistent with the Government policy to limit the short-
term debt, a ceiling of US $ 1 billion was assigned which was
increased to US $ 1.75 billion in 2004.
June 1998
Forward cover allowed in equity.
February
2000 Foreign firms and high net-worth individuals permitted to invest as
sub-accounts of FIIs. Domestic portfolio manager allowed to be
registered as FIIs to manage the funds of sub- accounts. The
objective was to allow operational flexibility and also give access to
domestic asset management capability.
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March
2001 FII ceiling under special procedure enhanced to 49 per cent. The
objective was to increase FII participation.
September
2001 FII ceiling under special procedure raised to sectoral capital.
December
2003 FII dual approval process of SEBI and RBI changed to single
approval process of SEBI. The objective was to streamline the
registration process and reduce the time taken for registration.
November
2004
Outstanding corporate debt limit of USD 0.5 billion prescribed. The
objective was to limit short term debt flows.
April 2006
Outstanding corporate debt limit increased to USD 1.5 billion
prescribed.
The limit on investment in Government securities was enhanced to
USD 2 bn. This was an announcement in the Budget of 2006-07.
November,
2006 FII investment upto 23% permitted in infrastructure companies in the
securities markets, viz. stock exchanges, depositories and clearing
corporations. This is a decision taken by Government following the
mandating of demutualization and corporatization of stock
exchanges.
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January
And October
2007
FIIs allowed to invest USD 3.2 billion in Government Securities
(limits were raised from USD 2 billion in two phases of USD 0.6
billion each in January and October).
June, 2008
While reviewing the External Commercial Borrowing policy, the
Government increased the cumulative debt investment limits from
US $3.2 billion to US $5 billion and US $1.5 billion to US $3 billion
for FII investments in Government Securities and Corporate Debt,
respectively.
October
2008
1: While reviewing the External Commercial Borrowing policy, the
Government increased the cumulative debt investment limits from
US $3 billion to US $6 billion for FII investments in Corporate Debt.
2: Removal of regulation for FIIs pertaining to restriction of 70:30
ratio of investment in equity and debt respectively.
3: Removal of Restrictions on Overseas Derivatives Instruments
(ODIs) Disapproval of FIIs lending shares abroad.
March
2009
E-bids platform for FIIs
August
2009 FIIs allowed to participate in interest rate futures
April 2010
FIIs allowed to offer domestic Government Securities and foreign
sovereign securities with AAA rating, as collateral to the recognized
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stock exchanges in India, in addition to cash, for their transactions in
the cash segment of the market.
November
2010 Investment cap for FIIs increased by US $ 5 billion each in
Government securitiesand corporate bonds to US $ 10 billion and US
$ 20 billion respectively.
3.3 Types of foreign Institutional Investors
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1. Pension funds:
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A pension fund is a pool of assets that form an independent legal entity that are
bought with the contributions to a pension plan for the exclusive purpose of financing
pension plan benefits. It manages pension and health benefits for employees, retirees,
and their families. FII activity in India gathered momentum mainly after the entry of
CAlPERS (California Public Employees’ Retirement System), a large US-based
pension fund in 2004.
2. Mutual fund.
A mutual fund is a type of professionally managed collective investment scheme that
pools money from many investors to purchase securities. While there is no legal
definition of the term "mutual fund", it is most commonly applied only to those
collective investment vehicles that are regulated and sold to the general public. They
are sometimes referred to as "investment companies" or "registered investment
companies". Most mutual funds are "open-ended", meaning stockholders can buy or
sell shares of the fund at any time by redeeming them from the fund itself, rather than
on an exchange. Hedge funds are not considered a type of mutual fund, primarily
because they are not sold publicly.
Mutual funds have both advantages and disadvantages compared to direct investing in
individual securities. They have a long history in the United States. Today they play
an important role in household finances, most notably in retirement planning.
There are 3 types of U.S. mutual funds: open-end, unit investment trust, and closed-
end. The most common type, the open-end fund, must be willing to buy back shares
from investors every business day. Exchange-traded funds (or "ETFs" for short) are
open-end funds or unit investment trusts that trade on an exchange. Open-end funds
are most common, but exchange-traded funds have been gaining in popularity.
Mutual funds are generally classified by their principal investments. The four main
categories of funds are money market funds, bond or fixed income funds, stock or
equity funds and hybrid funds. Funds may also be categorized as index or actively
managed.
Investors in a mutual fund pay the fund’s expenses, which reduce the fund's
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returns/performance. There is controversy about the level of these expenses. A single
mutual fund may give investors a choice of different combinations of expenses (which
may include sales commissions or loads) by offering several different types of share
classes.
3: Investment trust:
An Investment trust is a form of collective investment. Investment trusts are closed-
end funds and are constituted as public limited companies. A collective investment
scheme is a way of investing money with others to participate in a wider range of
investments than feasible for most individual investors, and to share the costs and
benefits of doing so.
4: Investment banks:
An investment bank is a financial institution that raises capital, trades in securities and
manages corporate mergers and acquisitions. Investment banks profit from companies
and governments by raising money through issuing and selling securities in capital
markets (both equity, debt) and insuring bonds (e.g. selling credit default swaps), as
well as providing advice on transactions such as mergers and acquisitions.
5: University Fund:
The purpose of investments of these funds is to establish an asset mix for each of the
University funds according to the individual fund’s spending obligations, objectives,
and liquidity requirements. It consists of the University’s endowed trust funds or other
funds of a permanent or long-term nature. In addition, external funds may be invested
including funds of affiliated organizations and funds where the University is a
beneficiary.
6: Endowment fund:
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It is a transfer of money or property donated to an institution, usually with the
stipulation that it be invested, and the principal remain intact in perpetuity or for a
defined time period. This allows for the donation to have an impact over a longer
period of time than if it were spent all at once.
7: Insurance Funds:
An insurance company’s contract may offer a choice of unit-linked funds to invest in.
All types of life assurance and insurers pension plans, both single premium and
regular premium policies offer these funds. They facilitate access to wide range and
types of assets for different types of investors.
8: Asset Management Company:
An asset management company is an investment management firm that invests the
pooled funds of retail investors in securities in line with the stated investment
objectives. For a fee, the investment company provides more diversification, liquidity,
and professional management consulting service than is normally available to
individual investors. The diversification of portfolio is done by investing in such
securities which are inversely correlated to each other. They collect money from
investors by way of floating various mutual fund schemes.
9: Nominee Company:
Company formed by a bank or other fiduciary organization to hold and administer
securities or other assets as a custodian (registered owner) on behalf of an actual
owner (beneficial owner) under a custodial agreement.
10: Charitable Trusts or Charitable Societies:
A trust created for advancement of education, promotion of public health and comfort,
relief of poverty, furtherance of religion, or any other purpose regarded as charitable
in law. Benevolent and philanthropic purposes are not necessarily charitable unless
they are solely and exclusively for the benefit of public or a class or section of it.
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Charitable trusts (unlike private or non-charitable trust) can have perpetual existence
and are not subject to laws against perpetuity. They are wholly or partially exempt
from almost all taxes.
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Chapter 4:
FOREIGN DIRECT INVESTMENT (FDI) VS. FOREIGN
INSTITUTIONAL INVESTORS (FII)
On the basis types of Investments
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FDI typically brings along with the financial investment, access to
moderntechnologies and export market. The impact of the FDI in India is far more
than thatof FII largely because the former would generally involve setting up of
productionbase - factories, power plant, telecom networks, etc. that enables direct
generation ofemployment. There is also multiplier effect on the back of the FDI
because of furtherdomestic investment in related downstream and upstream projects
and a host ofother services. Korean Steel maker Posco’s US$ 8 billion steel plant in
Orissa wouldbe the largest FDI in India once it commences. Maruti Suzuki has been
an exemplarycase in the India's experience. However, the issue is that it puts an
impact on localentrepreneur as he may not be able to always successfully compete in
the face ofsuperior technology and financial power of the foreign investor. Therefore,
it is oftenregulated that Foreign Direct Investments should ensure minimum level of
localcontent, have export commitment from the investor and ensure foreign
technologytransfer to India.
FII investments into a country are usually not associated with the direct benefits
interms of creating real investments. However, they provide large amounts of
capitalthrough the markets. The indirect benefits of the market include alignment of
localpractices to international standards in trading, risk management, new
instrumentsand equities research. These enable markets to become deeper, liquid,
feeding inmore information into prices resulting in a better allocation of capital to
globallycompetitive sectors of the economy. Since, these portfolio flows can
technicallyreverse at any time, the need for adequate and appropriate economic
regulations are imperative.
On the basis of Government’s Preference
FDI is preferred over FII investments since it is considered to be the most
beneficialform of foreign investment for the economy as a whole. Direct investment
targets aspecific enterprise, with the aim of enhancing capacity and productivity or
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changingits management control. Direct investment to create or augment capacity
ensuresthat the capital inflow translates into additional production. In the case of
FIIinvestment that flows into the secondary market, the effect is to increase
capitalavailability in general, rather than availability of capital to a particular
enterprise.
Translating an FII inflow into additional production depends on productiondecisions
by someone other than the foreign investor — some local investor has todraw upon
the additional capital made available via FII inflows to augmentproduction. In the
case of FDI that flows in for acquiring an existing asset, noaddition to production
capacity takes place as a direct result of the FDI inflow. Justlike in the case of FII
inflows, in this case too, addition to production capacity doesnot result from the
action of the foreign investor – the domestic seller has to investthe proceeds of the
sale in a manner that augments capacity or productivity for theforeign capital inflow
to boost domestic production. There is a widespread notionthat FII inflows are hot
money — that it comes and goes, creating volatility in thestock market and exchange
rates. While this might be true of individual funds, cumulatively, FII inflows have
only provided net inflows of capital
On the basis of Stability
FDI tends to be much more stable than FII inflows. Moreover, FDI brings not
justcapital but also better management and governance practices and, often,
technologytransfer. The knowhow thus transferred along with FDI is often more
crucial thanthe capital per se. No such benefit accrues in the case of FII inflows,
although thesearch by FIIs for credible investment options has tended to improve
accounting andgovernance practices among listed Indian companies.
Page 35
CHAPTER 5:
REGULATIONS OF FOREIGN INSTITUTIONAL INVESTORS
(FII)
Page 36
Modes of Investment by Foreign Investors in India
Page 37
5.1 Policy Developments for Foreign Investments
5.1.1 Allocation of Government debt & corporate debt investment limits to FIIs
SEBI, vide its circular dated November 26, 2010 has made the following decisions:
5.1.1.1 Increased investment limit for FIIs in Government and Corporate debt:
In an attempt to enhance FII investment in debt securities, government has increased
the currentlimit of FII investment in Government Securities by US $ 5 billion raising
the cap to US $ 10billion. Similarly, the current limit of FII investment in corporate
bonds has also been increasedby US $ 5 billion raising the cap to US $ 20 billion.
This incremental limit shall be invested incorporate bonds with residual maturity of
over five years issued by companies in the infrastructure sector...
5.1.1.2 Time period for utilization of the debt limits:
In July 2008, some changes pertaining to the methodology for the allocation of debt
limit hadbeen specified. In continuation of the same, SEBI has decided that the time
period forutilization of the corporate debt limits allocated through bidding process
(for both old and longterm infra limit) shall be 90 days. However, time period for
utilization of the government debtlimits allocated through bidding process shall
remain 45 days. Moreover, the time period forutilization of the corporate debt limits
allocated through first come first serve process shall be22 working days while that for
the government debt limits shall remain unchanged at 11working days.
Further, it was decided to grant a period of upto 15 working days for replacement of
the disposed off/ matured debt instrument/ position for corporate debt while that for
Governmentdebt will continue to be at 5 working days.
5.1.1.3 Government debt long terms:
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SEBI, vide its circular dated February 2009, had decided that no single entity shall be
allocatedmore than ` 10,000 crore of the investment limit. In a partial amendment to
this, SEBI, vide itscircular dated November 26, 2010, has decided that no single entity
shall be allocated more than 2000 crore of the investment limit. Where a singly entity
bids on behalf of multipleentities, then such bid would be limited to ` 2,000 crore for
every such single entity. Further, the minimum amount which can be bid for has been
made ` 200 crore and the minimum ticksize has been made ` 100 crore.
5.1.1.4 Corporate debt - Old limit:
SEBI has decided that no single entity shall be allocated more than ` 600 crore of
theinvestment limit. Where a singly entity bids on behalf of multiple entities, then
such bid wouldbe limited to ` 600 crore for every such single entity. Further, the
minimum amount which canbe bid for has been made ` 100 crore and the minimum
tick size has been made ` 50 crore.
5.1.1.5 Multiple bid order from single entity:
SEBI has allowed the bidder to bid for more than one entity in the bidding process
provided:
1) It provides due authorization to act in that capacity by those entities
2) It provides the stock exchanges, the allocation of the limits interse for the entities it
has bidfor to exchange with 15 minutes of close of bidding session.
5.1.1.6 FII investment into ‘to be listed’ debt securities
The market regulator has decided that FIIs will be allowed to invest in primary debt
issues onlyif listing is committed to be done within 15 days. If the debt issue could
not be listed within 15days of issue, then the holding of FIIs/subaccounts if disposed
off shall be sold off only todomestic participants/investors until the securities are
listed. This is in contrast to the earlierregulations issued in April 2006, wherein FII
investments were restricted to only listed debtsecurities of companies.
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5.1.2 Maintenance of Collateral by FIIs for Transactions in the Cash Segment
RBI, vide its circular dated April 12, 2010 has decided, in consultation with the
Government ofIndia and the SEBI, to permit the FIIs to offer domestic Government
securities and foreignsovereign securities with AAA rating, as collateral to the
recognized stock exchanges in India,in addition to cash, for their transactions in the
cash segment of the market.
5.1.3 Reporting of Lending of Securities bought in the Indian Market
SEBI, vide its circular dated June 29, 2010 has decided that the FIIs’ reporting of
lending ofsecurities bought in the Indian market will be done on weekly basis instead
of the erstwhiledaily submissions. In accordance with this change in periodicity of
reports, with effect fromJuly 02, 2010, FIIs are required to submit the reports every
Friday. Further, in view of thechange in the periodicity of the reporting, PN issuing
FIIs are required to submit the followingundertaking along with the weekly report:
"Any fresh short position shall be immediately reported to SEBI"
5.1.4 FII participation in Interest Rate Futures
FIIs have been allowed to participate in interest rate futures which were introduced
for tradingat NSE on August 31, 2009.
5.1.5 Rationalization of SEBI Fees for FIIs and FVCIs
SEBI has reduced its fees to be charged to FVIs and FIIs. This was effective from
July 2009onwards.
5.2 Evolution of policy framework
Until the 1980s, India’s development strategy was focused on self-reliance and
import-substitution. Current account deficits were financed largely through debt flows
and official development assistance. There was a general disinclination towards
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foreign investment or private commercial flows. Since the initiation of the reform
process in the early 1990s, however, India’s policy stance has changed substantially,
with a focus on harnessing the growing global foreign direct investment (FDI) and
portfolio flows. The broad approach to reform in the external sector after the Gulf
crisis was delineated in the Report of the High Level Committee on Balance of
Payments. It recommended, inter alia, a compositional shift in capital flows away
from debt to non-debt creating flows; strict regulation of external commercial
borrowings, especially short-term debt; discouraging volatile elements of flows from
non-resident Indians (NRIs); gradual liberalization of outflows; and dis-
intermediation of Government in the flow of external assistance.
After the launch of the reforms in the early 1990s, there was a gradual shift towards
capital account convertibility. From September 14, 1992, with suitable restrictions,
FIIs and Overseas Corporate Bodies (OCBs) were permitted to invest in financial
instruments. The policy framework for permitting FII investment was provided under
the Government of India guidelines vide Press Note dated September 14, 1992, which
enjoined upon FIIs to obtain an initial registration with SEBI and also RBI’s general
permission under FERA. Both SEBI’s registration and RBI’s general permissions
under FERA were to hold good for five years and were to be renewed after that
period. RBI’s general permission under FERA could enable the registered FII to buy,
sell and realize capital gains on investments made through initial corpus remitted to
India, to invest on all recognized stock exchanges through a designated bank branch,
and to appoint domestic custodians for custody of investments held.
The Government guidelines of 1992 also provided for eligibility conditions for
registration, such as track record, professional competence, financial soundness and
other relevant criteria, including registration with a regulatory organization in the
home country. The guidelines were suitably incorporated under the SEBI (FIIs)
Regulations, 1995. These regulations continue to maintain the link with the
government guidelines through an inserted clause that the investment by FIIs would
also be subject to Government guidelines. This linkage has allowed the Government
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to indicate various investment limits including in specific sectors. With coming into
force of the Foreign Exchange Management Act, (FEMA), 1999 in 2000, the Foreign
Exchange Management (Transfer or issue of Security by a Person Resident outside
India) Regulations, 2000 were issued to provide the foreign exchange control context
where foreign exchange related transactions of FIIs were permitted by RBI.
A philosophy of preference for institutional funds, and prohibition on portfolio
investments by foreign natural persons has been followed, except in the case of Non-
resident Indians, where direct participation by individuals takes place. Right from
1992, FIIs have been allowed to invest in all securities traded on the primary and
secondary markets, including shares, debentures and warrants issued by companies
which were listed or were to be listed on the Stock Exchanges in India and in schemes
floated by domestic mutual funds.
5.3 Market Design - FIIs
I. Entities eligible to invest under FII route:
i. An institution established or incorporated outside India as a pension fund,
mutual fund, investment trust, insurance company or reinsurance company;
ii. An International or Multilateral Organization or an agency thereof or a
Foreign Governmental Agency, Sovereign Wealth Fund or a Foreign Central
Bank;
iii. An asset management company, investment manager or advisor, bank or
institutional portfolio manager, established or incorporated outside India and
proposing to make investments in India on behalf of broad based funds and its
proprietary funds, if any;
iv. A Trustee of a trust established outside India, and proposing to make
investments in India on behalf of broad based funds and its proprietary funds, if
any
v. University fund, endowments, foundations or charitable trusts or charitable
societies. Broad based fund means a fund established or incorporated outside
India, which has at least 20 investors with no single individual investor holding
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more than 49 percent of the shares or units of the fund. If the broad based fund
has institutional investor(s), then it is not necessary for the fund to have 20
investors. Further, if the broad based fund has an institutional investor who holds
more than 49 percent of the shares or units in the fund, then the institutional
investor must itself be a broad based fund. Sub-account means any person
resident outside India, on whose behalf investments are proposed to be made in
India by a foreign institutional investor and who is registered as a subaccount
under the SEBI (FII) Regulations, 1995. Applicant for sub-account can fall into
any of the following categories, namely:
i. Broad based fund or portfolio which is broad based, incorporated or
established outside India.
ii. Proprietary fund of a registered foreign institutional investor.
iii. Foreign corporate (which has its securities listed on a stock exchange
outside India, having asset base of not less than US $ 2 billion and having an
average net profit of not less than US $ 50 million. A non-resident Indian shall
not be eligible to invest as sub-account.
5.3.1 Investment Restrictions OF FII
An FII can invest only in the following:
1: securities in the primary and secondary markets including shares, debentures and
warrants of companies, unlisted, listed or to be listed on a recognized stock exchange
in India.
2: units of schemes floated by domestic mutual funds including Unit Trust of India,
whether listedor not listed on a recognized stock exchange; units of scheme floated by
Collective InvestmentScheme.
3: dated Government securities and
4: derivatives traded on a recognized stock exchange
5: commercial paper
6: security receipts
7: Indian Depository Receipts
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In case foreign institutional investor or sub-account holds equity shares in a company
whose shares arenot listed on any recognized stock exchange, and continues to hold
the shares after initial public offering and listing thereof, such shares would be subject
to lockin for the same period, if any is applicable to shares held by a foreign direct
investor placed in similar position, under the policy of the Central Government
relating to foreign direct investment for the time being in force.
The total investments in equity and equity related instruments (including fully
convertible debentures, convertible portion of partially convertible debentures and
tradable warrants) made by a FII in India, whether on his own account or on account
of his sub- accounts, should not be less than 70 per cent of the aggregate of all the
investments of the Foreign Institutional Investor in India, made on his ownaccount
and on account of his subaccounts.
However, this is not applicable to any investment of the FII either on its own account
or on behalf ofits sub-accounts in debt securities which are unlisted or listed or to be
listed on any stock exchange ifthe prior approval of the SEBI has been obtained for
such investments.
Further, SEBI while grantingapproval for the investments may impose conditions as
are necessary with respect to the maximum amount which can be invested in the debt
securities by the foreign institutional investor on its ownaccount or through its sub-
accounts. A foreign corporate or individual shall not be eligible to invest through the
100 percent debt route.
Investments made by FIIs in security receipts issued by securitization companies or
asset reconstruction companies under the Securitization and Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002 are not eligible
for the investment limits mentioned above.
No foreign institutional investor can invest in security receipts on behalf of its sub-
accounts.
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5.3.2 FII Investment in secondary markets:
SEBI regulations provide that a foreign institutional investor or sub-account can
transact in the Indiansecurities market only on the basis of taking and giving delivery
of securities purchased or sold.
However, this does not apply to any transactions in derivatives on a recognized stock
exchange.Further, SEBI has, in December, 2007 permitted FIIs and sub-accounts can
enter into short sellingtransactions only in accordance with the framework specified
by SEBI. No transaction on the stockexchange can be carried forward and the
transaction in securities would be only through stock brokerwho has been granted a
certificate by SEBI. They have also been allowed to lend or borrow securitiesin
accordance with the framework specified by SEBI in this regard.
The purchase of equity shares of each company by a FII investing on his own account
should notexceed 10 percent of the total issued capital of that company. FII investing
in equity shares of acompany on behalf of his sub-accounts, the investment on behalf
of each such sub-account should notexceed 10 percent of the total issued capital of
that company. In case of foreign corporate orindividuals, each of such sub-account
should not invest more than five percent of the total issuedcapital of the company in
which such investment is made.
A Foreign institutional investor can issue, or otherwise deal in offshore derivative
instruments, directly of indirectly wherein the offshore derivative instruments are
issued only to persons who are regulatedby an appropriate foreign regulatory
authority and the ODIs are issued after compliance with ‘know your client’ norms.
5.3.3 General Obligations and Responsibilities
Certain general obligations and responsibilities relating to appointment of domestic
custodians, designated bank, investment advice in publicly accessible media etc. have
been laid down on the FIIs operating in the country in the SEBI (FII) Regulations,
1995.
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5.3.4 Private Placement with FIIs
SEBI registered FIIs have been permitted to purchase shares/convertible debentures of
an Indian company through offer/private placement subject to the ceiling of 10
percent of the paid up capital of the Indian company for individual FII/sub account
and 24 percent for all FIIs/sub-accounts put together. Indian company is permitted to
issue such shares provided that:
5.3.4.1 In the case of public offer, the price of shares to be issued is not less than the
price at which shares are issued to residents and
5.3.4.2 In the case of issue by private placement, the price is not less than the price
arrived at in termsof SEBI guidelines or guidelines issued by the erstwhile Controller
of Capital issues asapplicable. Purchases can also be made of Partially Convertible
debentures, Fully Convertibledebentures, Rights/Renunciations/Warrants/Units of
Domestic Mutual Fund Schemes.
5.4 Risk Management
5.4.1 Forward Cover & Cancellation and Rebooking
Authorized Dealer Banks can offer forward cover to FIIs to the extent of total inward
remittance of liquidated investment. Rebooking of cancelled forward contracts is
allowed up to a limit of 2 percent of the market value of the entire investment of FIIs
in equity and/or debt in India. The limit for calculating the eligibility for rebooking
will be based upon market value of the portfolio as at the beginning of the financial
year (April-March).
The outstanding contracts have to be duly supported by underlying exposure at all
times.
The AD Category-I bank has to ensure that (i) that total forward contracts outstanding
does not exceed the market value of portfolio and (ii) forward contracts permitted to
be rebooked does not exceed 2 percent of the market value as determined at the
beginning of the financial year. The monitoring of forward cover is to be done on a
fortnightly basis.
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5.4.1.1 FII Position Limits In Derivatives Contracts
SEBI registered FIIs are allowed to trade in all exchange traded derivative contracts
on the stock exchanges in India subject to the position limits as prescribed by SEBI
from time to time. Clearing Corporation monitors the open positions of the FII/sub-
accounts of the FII for each underlying security and index, against the position limits
specified at the level of FII/sub accounts of FII respectively, at the end of each trading
day.
5.4.2 Monitoring of investment position by RBI
The Reserve Bank of India (RBI) monitors the investment position of FIIs in listed
Indian Companies, reported by Custodian/designated AD banks on a daily basis, in
Forms LEC (FII).
5.4.3 Caution List
When the total holdings of FIIs under the Scheme reach the limit of 2 percent below
the sectoral cap, RBI issues a notice to all designated branches of AD Category - 1
banks cautioning that any further purchases of shares of the particular Indian company
will require prior approval of RBI. RBI gives case-by case approvals to FIIs for
purchase of shares of companies included in the Caution List. This is done on a first-
come-first served basis.
5.4.4 Ban List
Once the shareholding by FIIs reaches the overall ceiling/sectoral cap/statutory limit,
RBI places the company in the Ban List. Once a company is placed on the Ban List,
no FII or NRI can purchase the shares of the company under the Portfolio Investment
Scheme.
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5.4.5 Margin Requirements
SEBI registered FIIs/sub-accounts are allowed to keep with the trading
member/clearing member amount sufficient to cover the margins prescribed by the
exchange/Clearing House and such amounts as may be considered to meet the
immediate
5.4.6 Reporting of FII Investments
An FII may invest in a particular share issue of an Indian Company either under the
FDI scheme or the Portfolio Investment Scheme. The AD Category-I banks have to
ensure that the FIIs who are purchasing the shares by debit to the Special Non-
Resident Rupee Account report these details separately in the Form LEC (FII).
5.4.7 Investment by FIIs under Portfolio Investment Scheme
RBI has given general permission to SEBI registered FIIs/sub-accounts to invest
under the Portfolio Investment Scheme (PIS).
Total holding of each FII/sub account under this scheme should not exceed
10% of the total paid up capital or 10% of the paid up value of each series of
convertible debentures issued by the Indian company.
Total holding of all the FIIs/sub-accounts put together should not exceed 24%
of the paid up capital or paid up value of each series of convertible debentures. This
limit of 24% can be increased to the sectoral cap / statutory limit as applicable to the
Indian Company concerned, by passing a resolution of its Board of Directors followed
by a special resolution to that effect by its General Body.
A domestic asset management company or portfolio manager, who is
registered with SEBI as an FII for managing the fund of a sub-account can make
investments under the Scheme on behalf of:
1) A person resident outside India who is a citizen of a foreign state or
2) A body corporate registered outside India.
However, such investment should be made out of funds raised or collected or
brought from outside through normal banking channel. Investments by such entities
should not exceed 5% of the total paid up equity capital or 5% of the paid up value of
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each series of convertible debentures issued by an Indian company, and should also
not exceed the overall ceiling specified for FIIs.
5.5 Unique Risks of and Institutional Constraints for Foreign
InstitutionalInvestors
5.5.1 Unique Risks of International Portfolio Investment
Unfortunately, there are not only benefits from IPI that simply wait to be taken
advantage of, but thereare also some unique risks and constraints that arise when
extending the scope of securities held to an international scale. These are easily
overlooked, but nevertheless have to be included in the analysis when
comprehensively assessing the IPI phenomenon, since they might influence the
investmentdecision or its implementation considerably.
5.5.1.1 Currency Risk
In what follows, the unique aspects of risk due to international diversification of
investment portfolioswill be analyzed in more detail. The major point is that improved
portfolio performance as a result of international portfolio investment must be shown
after allowing for these risk and cost components.
For convenience as well as analytical clarity, the unique international risk can be
divided into two components:
A: exchange risk (broadly defined)
B: political (or country) risk.
5.5.1.2 Country Risk
The fact that a security is issued or traded in a different and sovereign political
jurisdiction than that of the consumer-investor gives rise to what is referred to as
country risk or political risk. Country risk ingeneral can be categorized into transfer
risks (restrictions on capital flows), operational risks (constraints on management and
corporate activity) and ownership-control risks (government policieswith regard to
ownership/managerial control). It embraces the possibility of exchange controls,
expropriation of assets, changes in tax policy (like withholding taxes being
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imposedafter the investment is undertaken) or other changes in the business
environment of the country. Ineffect, country risk are local government policies that
lower the actual (after tax) return on the foreign investment or make the repatriation
of dividends, interest, and principal more difficult. Malaysia's actions in 1997/98
represents a textbook example why country risk is still a concern to foreign portfolio
Investors. Political risk also includes default risk due to government actions and the
general uncertainty regarding political and economic developments in the foreign
country. In order to deal with these issues, theinvestor needs to assess the country's
prospects for economic growth, its political developments, and itsbalance of payments
trends. Interestingly, political risk is not unique to developing countries.
In addition to assessing the degree of government intervention in business, the ability
of the labor forceand the extent of a country's natural resources, the investor needs to
appraise the structure, size, andliquidity of its securities markets. Information and data
from published financial accounting statementsof foreign firms may be limited;
moreover, the information available may be difficult to interpret due
to incomplete or different reporting practices,
This information barrier is another aspect ofcountry risk. Indeed, it is part of the
larger issue of corporate governance and the treatment of foreign (minority) investors,
mentioned earlier. At this point it is worth noting that in many countries
foreigninvestors are under a cloud of suspicion which often stems from a history of
colonial domination.
5.5.2 Institutional Constraints for International Portfolio Investment
Institutional constraints are typically government-imposed, and include taxes, foreign
exchangecontrols, and capital market controls, as well as factors such as weak or
nonexistent laws protecting therights of minority stockholders, the lack of regulation
to prevent insider trading, or simply inadequaterules on timely and proper disclosure
of material facts and information to security holders. Their effecton international
portfolio investment appears to be sufficiently important that the theoretical
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benefitsmay prove difficult to obtain in practice. This is, of course, the very reason
why segmented marketspresent opportunities for those able to overcome the barriers.
However, when delineating institutional constraints on international portfolio
investment, it must berecognized that these barriers are somewhat ambiguous.
Depending on one's viewpoint, institutionalconstraints can turn out to be incentives:
what is a constraint in one market (high transaction costs, forexample), turns into an
incentive for another market. Or, while strict regulation of security issues may
be designed for the protection of investors, if administered by an inept bureaucracy it
can prove to be aconstraint for both issuers and investors.
5.5.2.1 Taxation
When it comes to international portfolio investment, taxes are both an obstacle as well
as an incentive to cross-border activities. Not surprisingly, the issues are complex -- in
large part because rulesregarding taxation are made by individual governments, and
there are many of these, all having verycomplex motivations that reach far beyond
simply revenue generation. In the present context, it is notdetails but a framework or
"pattern" of tax considerations affecting IPI that is of foremost interest.
It is obvious then, since tax laws are national, that it is individual countries that
determine the tax ratespaid on various returns from portfolio investment, such as
dividends, interest and capital gains. All these rules differ considerably from country
to country. Countries also differ in terms of institutionalarrangements for investing in
securities, but in all countries there are institutional investors which maybe tax
exempt (e.g. pension funds) or have the opportunity for extensive tax deferral
(insurancecompanies).
5.5.2.3 Capital Market Regulations
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Regulations of primary and secondary security markets typically aim at protecting the
buyer offinancial securities and try to ensure that transactions are carried out on a fair
and competitive basis.
These functions are usually accomplished through an examining and regulating body,
such as theSecurities and Exchange Commission (SEC) in the United States, long
regarded as exemplary inguarding investor interests, or the "Commitee des Bourses et
Valeurs" in France. Supervision andcontrol of practices and information disclosure by
a relatively impartial body is important formaintaining investors' confidence in a
market; it is crucial for foreign investors who will have even lessdirect knowledge of
potential abuses, and whose ability to judge the conditions affecting returns
onsecurities may be very limited.
Most commonly, capital market controls manifest themselves in form of restrictions
on the issuance ofsecurities in national capital markets by foreign entities, thereby
making foreign securities unavailable
to domestic investors. Moreover, some countries put limits on the amount of
investment local investorscan do abroad or constrain the extent of foreign ownership
in national companies. While fewindustrialized countries nowadays prohibit the
acquisition of foreign securities by private investors, institutional investors face a
quite different situation. Indeed, there is almost no country where
financialinstitutions, insurance companies, pension funds, and similar fiduciaries are
not subject to rules andregulations that make it difficult for them to invest in foreign
securities.
In the United States, for example, different state regulations severely constrain the
proportion ofinsurance company portfolios invested in foreign securities. In some
states, institutions, such aspension funds for public employees including teachers,
cannot invest in foreign securities at all.
Similarly, state banking regulations specify severe limits for commercial banks, and
trustees of evenprivate pension funds have been plagued by the uncertainties of legal
interpretation of the "prudentman's rule," effectively limiting the acquisition of
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foreign securities. In most other countries, there are similar or even more binding
restrictions.
5.5.2.4 Transaction Costs
Transaction costs associated with the purchase of securities in foreign markets tend to
be substantiallyhigher compared to buying securities in the domestic market. Clearly,
this fact serves as an obstacle toIPI. Trading in foreign markets causes extra costs for
financial intermediaries, because access to themarket can be expensive. The same is
true for information about prices, market movements, companies
and industries, technical equipment and everything else that is necessary to actively
participate intrading. Moreover, there are administrative overheads, costs for the data
transfer between the domesticbank and its foreign counterpart (be it a bank
representative or a local partner institution. Therefore, financial institutions try to pass
these costs on to their customers, i.e. the investor. Simply timedifferences can be a
costly headache, due to the fact that someone has to do transactions at timesoutside
normal business hours.
However, transactions costs faced by international investors can be mitigated by the
characteristic of "liquidity," providing depth, breadth, and resilience of certain capital
markets, thus reducing thisconstraint and -- as a consequence -- inducing international
portfolio investment to these countries.
Issuers from the investors' countries will then have a powerful incentive to list their
securities on the exchange(s) of such markets.
The development of efficient institutions, the range of expertise and experience
available, the volume of transactions and breadth of securities traded, and the
readiness with which the market can absorb large, sudden sales or purchases of
securities at relatively stable prices all vary substantially fromcountry to country. The
U.S. and British markets have a reputation for being superior in these respects, and
have attracted a large amount of international portfolio investment as a result. These
markets can offer and absorb a wide variety of securities, both with regard to type
(bonds, convertibles, preferred shares, ordinary shares, money market instruments,
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etc.) and with regard to issuer (public authorities, banks, non bank financial
institutions, private companies, foreign and international institutions, etc.).
They offer depth, being able to supply and absorb substantial quantities of different
securities at close to the current price, where as in Continental Europe and Asia one
often hears complaints about the"thinness" of the securities markets leading to
random volatility of prices. Therefore, all other factorsbeing equal, investors are
attracted to markets where transactions are conducted efficiently and at a low cost to
borrower and lender, buyer and seller. Historically, New York has provided foreign
investors with one of the most efficient securities markets in the world.
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CHAPTER 6:
BENEFITS AND LIMITATIONS OF FOREIGN INSTUTIONAL
INVESTORS (FII)
6.1 BENEFITS OF FOREIGN INSTUTIONAL INVESTORS (FII)
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Benefits of FII Investment:
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6.1.1. Enhanced flows of equity capital:
FIIs are well known for a greater appetite for equity than debt in their assetstructure.
For examples, pension funds in the United Kingdom and United stateshad 68 percent
and 64 percent, respectively of their portfolios in equity in 1998. Thus, opening up the
economy to FIIs is in line with the accepted preference for non-debtcreating foreign
inflows over foreign debt. Furthermore, because of this preference for equities over
bonds, FIIs can help in compressing the yield-differential betweenequity and bonds
and improve corporate capital structures. Further, given theexisting saving investment
gap of around 1.6 percent, FII inflows can also contributein bridging the investment
gap. So that sustained high GDP growth rate of around 8percent targeted under the
10th five year plan can be materialize. Equity return has asignificant and positive
impact on the FII investment. But given the huge volume of investments,
foreigninvestment could play a role of market makers and book their profits and
enhancedequity capital in the host country.
6.1.2. Improving capital markets:
FIIs as professional bodies of asset managers and financial analyst’s enhance
competition and efficiency of financial markets. Equity market development aids
economic development. By increasing the availability of riskier long term capital for
projects, and increasing firms’ incentives to supply more information about
themselves, the FIIs can help in the process of economic development. Theincreasing
role of institutional investors has brought both quantitative and qualitative
developments in the stock markets viz., expansion of securities business,increased
depth and breadth of the market, and above all their dominant investment philosophy
of emphasizing the fundamentals has rendered efficient pricing of thestocks
suggested that foreign portfolio investmentswould help the stock markets directly
through widening investors’ base andindirectly by compelling local authorities to
improve the trading system.
6.1.3. Improved corporate governance:
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Good corporate governance is essential to overcome the principal-agent problem
between share-holders and management. Information asymmetries and incomplete
contracts between share-holders and management are at the root of the agency costs.
Dividend payment, for example, is discretionary. Bad corporate governance
makesequity finance a costly option. With boards often captured by managers or
passive, ensuring the rights of shareholders is a problem that needs to be
addressedefficiently in any economy. Incentives for shareholders to monitor firms and
enforcetheir legal rights are limited and individuals with small share-holdings often
do notaddress the issue since others can free-ride on their endeavor. What is a needed
islarge shareholder with leverage to complement their legal rights and overcome
thefree-rider problem, but shareholding beyond say 5 per cent can also lead
toexploitation of minority shareholders. FIIs constitute professional bodies of
assetmanagers and financial analysts, who, by contributing to better understanding
offirms’ operations, improve corporate governance. Among the four models
ofcorporate control – takeover or market control via equity, leveraged control
ormarket control via debt, direct control via equity, and direct control via debt
orrelationship banking – the third model, which is known as corporate governance
movement, has institutional investors at its core. In this third model,
boardrepresentation is supplemented by direct contacts by institutional investors.
Institutions are known for challenging excessive executive compensation, and remove
underperforming managers.
6.1.4. Managing uncertainty and controlling risks:
Institutional investors promote financial innovation and development of
hedginginstruments. Institutions, for example, because of their interest in hedging
risks, are known to have contributed to the development of zero-coupon bonds and
index futures. FIIs, as professional bodies of asset managers and financial analysts,
notonly enhance competition in financial markets, but also improve the alignment
ofasset prices to fundamentals. Institutions in general and FIIs in particular are
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knownto have good information and low transaction costs. By aligning asset prices
closer to fundamentals, they stabilize markets. Fundamentals are known to be
sluggish in their movements. Thus, if prices are aligned to fundamentals, they should
be asstable as the fundamentals themselves. Furthermore, a variety of FIIs with a
variety of risk-return preferences also help in dampening volatility.
6.1.5. Reduced cost of equity capital:
FII inflows augment the sources of funds in the Indian capital markets. In a
commonsense way, the impact of FIIs upon the cost of equity capital may be
visualized byasking what stock prices would be if there were no FIIs operating in
India. FII investment reduces the required rate of return for equity, enhances stock
prices, and foster investments by Indian firms in the country. From the perspective of
international investors, the rapidly growing emerging markets offer potentially higher
rates of return and help in diversifying portfolio risk. It is argued that FPI flows
increase the stock prices in the recipients markets, which in turn increases the Price-
Earning (P/E) ratio of the concerned firms. Increase in P/E ratio tends to reduce the
cost of capital and boosts the stock markets. This phenomenon has been witnessed in
the case of Asian and Latin American countries. The costof equity capital is also cut
down due to the sharing of risk by the foreign investors.
This reduction in the cost of equity could result in increased physical investment
(Henry, 2000). Some investment projects with a negative Net Present Value (NPV)
before the entry of foreign investors can turn into projects with positive NPV after
their entry. As a result, there is boost to primary issues in such markets.
6.1.6. Imparting stability to India’s Balance of Payments:
For promoting growth in a developing country such as India, there is need to augment
domestic investments, over and beyond domestic saving, through capitalflows. The
excess of domestic investment over domestic savings result in a current account
deficit and this deficit is financed by capital flows in the balance of payments
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6.1.8. Knowledge Flows:
The activities of international institutional investors help strengthen Indian finance.
FIIs advocate modern ideas in market design, promote innovation development of
sophisticated products such as financial derivatives, enhance competition infinancial
intermediation, and lead to spillovers of human capital by exposing Indian
participants to modern financial techniques, and international best practices and
systems.
6.1.9. Improvements to market efficiency:
A significant presence of FIIs in India can improve market efficiency through two
channels. First, when adverse macro economic news, such as bad monsoons, unsettles
many domestic investors, it may be easier for a globally diversified portfolio manager
to be more dispassionate about India’s prospects and engage instabilizing trades.
Second, at a level of individual stocks and industries, FIIs may act as a channel
through which knowledge and ideas about valuation of a firm or an industry can more
rapidly propagate into India. For example, foreign investors were rapidly able to
assess the potential of the firms like Infosys, which are primarilyexpert oriented,
applying valuation principles, and the prevailed outside India forsoftware services
companies. In the Indian context, the FIIs are said to have seen instrumental in
promoting market efficiency and transparency (Chopra, 1995). The argument, in favor
of this conclusion, is that the advent of FIIs has benefited all investors by offering
them a wider range of instruments with varying degrees of risk, return and liquidity.
Hence, the policy measures have been targeted towards promoting more FII
investment.
6.2 Limitations of FII Investment
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6.2.1 Volatility and capital outflows:
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There is also increasing possibility of abrupt and sudden outflows of capital if
theinflows are of a short-term nature as in the case of portfolio inflows of FIls.
Therecent experience of reversal of private capital flows observed in Global crisis of
2008, Asian crisis in 1997 and in Mexico during the later part of 1994 due to sudden
change in FIIs' investment sentiment provides a vivid illustration of such risks.
FIls take into account some specific risks in emerging markets such as
(i) political instability and economic mismanagement,
(ii) liquidity risk and
(iii) Currency movement. Currency movement can have a dramatic impact on
equity returns of FIIs, a depreciation having an adverse effect.
The withdrawal of FIIs from ASEAN countries led to large inflow of funds to FIIs to
India for which equity market in India is buoyant at present. Thus, short-term flows
including portfolio flows of FIIs to developing countries in particular are inherently
unstable and increases volatility of the emerging equity markets. They are speculative
andrespond adversely to any instability either in the real economy or in financial
variables. Investment in emerging markets by FIIs can at times be driven more by
aperceived lack of opportunities in industrial countries than by sound fundamental sin
developing countries including India. Emerging stock markets of India and other
developing countries have a low, even negative correlation with the stock markets in
industrial nations. So, when the latter goes down, FIIs invest more in the former as a
means to reduce overall portfolio risk. On the other hand, if there is a boom in
industrial country, there may be reverse flow of funds of FIIs from India and other
developing countries. Of course, there is pull for international private portfolio
investment of FIIs due to the impact of wide-ranging macro-economic and structural
reforms including liberalization or elimination of capital restrictions, improved flow
of financial information, strengthening investors' protection and the removal
ofbarriers on FIIs' participation in equity markets in India and other emerging
markets.
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However, to the extent, FIIs view emerging markets as a single-asset class, shocks in
one country or region can also be transmitted to other emerging markets producing
volatile collapsing share price behavior. FII inflows are popularly described as “hot
money”, because of the herding behavior and potential for large capital outflows.
Herding behavior, with all the FIIs trying to either only buy or only sell at the same
time, particularly at times of market stress, can be rational. With performance-related
fees for fund managers, and performance judged on the basis of how other funds are
doing, there is great incentive to suffer the consequences of being wrong when
everyone is wrong, rather than taking the risk of being wrong when some others are
right. The incentive structure highlights the danger of a contrarian bet going wrong
and makes it much more severe than performing badly along with most others in the
market. It not only leads to reliance on the same information as others but also
reduces the planning horizon to a relatively short one. Another source of concern are
hedge funds, who unlike pension funds, life insurance companies and mutual
funds,engage in short-term trading, take short positions and borrow more
aggressively,and numbered about 6,000 with $500 billion of assets under control in
1998.
6.2.2 Price rigging:
Bear hammering by FIIs has been alleged in case of almost all companies in India
tapping the GDR market. The cases of SBI and VSNL are most illuminating to
showhow the FIIs manipulates domestic market of a company before its GDR issues.
The manipulation of FIIs, working in collusion operates in the following way. First,
they sell en masse and then when the price has been pulled down enough pick up
thesome shares cheaply in the GDR market. Though FIIs have the freedom of entry
andexit, they alone have the access to both the domestic as well as the GDR market
butthe GDR market is not open to domestic investors. Hence FIIs gain a lot at the cost
ofdomestic investors due to their manipulation which is possible owing to integration
of Indian equity market with global market consequent upon liberalization.
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6.2.3 Herding and positive feedback trading:
There are concerns that foreign investors are chronically ill-informed about India, and
this lack of sound information may generate herding (a larger number of FIIs buying
or selling together). These kinds of behavior can exacerbate volatility, andpush prices
away from fair values. FIIs behavior in India however, so far does not exhibit these
patterns. FIIs have come to play a dominant role in the India’s stock market like never
before. The pace of their inflows into equities is picking up momentum over the years.
6.2.4 BOP vulnerability:
There are concerns that in an extreme event, there can be a massive flight of foreign
capital out of India, triggering difficulties in the balance of payments front.
India’sexperience with FIIs so far, however, suggests that across episodes like the
Pokhran blasts, or the 2001 stock market scandal, no capital flight has taken place. A
billion ormore of US dollars of portfolio capital has never left India within the period
of onemonth. When juxtaposed with India’s enormous current account and capital
flows, this suggests that there is little evidence of vulnerability so far.
6.2.5 Possibility of taking over companies or backdoor control:
Besides price rigging, FIIs are trying to control indigenous companies through the
GDR route where they are also active. GDRs acquire the voting rights once an
ordinary share gets converted into equity within a specified limit. So, the GDR route
which is considered as FDI plus portfolio investment is a roundabout way adopted by
FIIs to gain control of indigenous companies. While FIIs are normally seen as pure
portfolio investors can occasionally behave like FDI investors, and seek control of
companies that they have a substantial shareholding in. Such outcome, however, may
not be inconsistent with India’s quest for greater FDI. Furthermore, SEBI’s takeover
code is in place and has functional fairly well, ensuring that all investors benefit
equally in the event of a takeover.
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6.2.6 Money laundering:
The movement of hot money of FIIs due to integration of emerging markets of India
and other countries with global market have helped the hawala traders and criminal
elements an easy means to launder international money from illegal activities which
in consequence have also an impact on equity market. Sometimes FIIs act as an
agentfor money laundering. It is also argued that the FII indulgein price rigging by
collusive operation. Another ill effect of opening up of the capital market to FIIs has
been the possibility of FIIs trying to gain control of indigenous companies. Finally, it
is alleged that FIIs might indulge in money laundering transactions.
6.2.7 Management control
FIIs act as agents on behalf of their principals – as financial investors maximizing
returns. There are domestic laws that effectively prohibit institutional investors from
taking management control. For example, US law prevents mutual funds fromowning
more than 5 per cent of a company’s stock. According to the International Monetary
Fund’s Balance of Payments Manual 5, FDI is that category of international
investment that reflects the objective of obtaining a lasting interest by aresident entity
in one economy in an enterprise resident in another economy. The lasting interest
implies the existence of a long-term relationship between the direct investor and the
enterprise and a significant degree of influence by the investor in the management of
the enterprise. According to EU law, foreign investment is labeled direct investment
when the investor buys more than 10 per cent of the investment target, and portfolio
investment when the acquired stake is less than 10 percent. Institutional investors on
the other hand are specialized financial intermediaries managing savings collectively
on behalf of investors, especially small investors, towards specific objectives in terms
of risk, returns, and maturity of claims.
All take-overs are governed by SEBI (Substantial Acquisition of Shares and
Takeovers) Regulations, 1997, and sub-accounts of FIIs are deemed to be “persons
acting in concert” with other persons in the same category unless the contrary is
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established. In addition, reporting requirement has been imposed on FIIs and currently
Participatory Notes cannot be issued to un-regulated entities abroad.
Some of these issues have been relevant right from 1992, when FII investments were
allowed in.
The issues, which continue to be relevant even today, are:
(i) Bench marking with the best practices in other developing countries that
compete with India for similar investments;
(ii) if management control is what is to be protected, is there a reason to put a
restriction on the maximum amount of shares that can be held by a foreign
investor rather than the maximum that can be held by all foreigners put
together; and;
(iii) Whether the limit of 24 per cent on FII investment will be over and above
the 51 per cent limit on FDI.
There are some other issues such as whether the existing ceiling on the ratio between
equities and debentures in an FII portfolio of 70:30 should continue or not, but this is
beyond the terms of reference of the Committee. It may be noted that all emerging
peer market shave some restrictions either in terms of quantitative limits across the
board or inspecified sectors, such as, telecom, media, banks, finance companies, retail
tradingmedicine, and exploration of natural resources. Against this background,
further across the board relaxation by India in all sectors except a few very specific
sectors to be excluded, may considerably enhance the attractiveness of India as a
destination for foreign portfolio flows. It is felt that with adequate institutional
safeguards no win place the special procedure mechanism for raising FII investments
beyond 24 percent may be dispensed with.
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Chapter 7: Conclusion
(wrong)
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The present research has clearly established the relation that in short run FIIs do not
cause volatility in Indian markets but, the volatility in the Indian market does make it
difficult for FIIs to retain the investment and they withdraw money from the Indian
market making the losses bigger for both domestic and foreign investors in India.
At last I would like to quote in the words of Allan Watts that
“A Myth is an image in which we try to make the sense of the world”
So, at the end one should always remember that before reaching to a conclusion it
better always, to check the real cause of an incident and then comment on it because,
what one see with his/her own eyes is sometimes not the correct picture. Before
blaming any one for a wrong doing we should always take due care that whatever we
speak is at least checked and proved correct.
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