Foreign investors are preferring to access the Indian market through the sub-account route rather than coming in as foreign institutional investors (FIIs), thanks to stricter regulatory norms and tax-related concerns related to the proposed general anti-avoidance rules (GAAR).
The number of registered sub-accounts has gone up to 6,343 as of July 31 from 6,278 at the end of 2011, according to Securities and Exchange Board of India (Sebi) data. In contrast, the number of registered FIIs has come down to 1,757 from 1,767 during the same period.
An FII is an institution established or incorporated outside India that proposes to make investments in Indian securities. Sub-accounts are entities that include foreign companies, foreign individuals and institutions, funds or portfolios established or incorporated outside India, on whose behalf FIIs propose to make investments in India. Both FIIs and their sub-accounts are required to register with Sebi.
The compliance requirements for FIIs are much higher compared to that for sub-accounts. Also, the registration process for sub-accounts is much quicker and less expensive compared with that of FIIs.
According to legal experts who advise foreign investors, Sebi has directed FIIs registered under the 'investment manager' category and which do not have broader investor base, to register their clients as sub-accounts or surrender their registration. FIIs registered under the investment managers category handle funds on behalf of their clients.
Several FIIs which have not been able to comply with Sebi's directive have given up their licences, says Siddharth Shah, head of corporate and securities practice group at law firm Nishith Desai Associates. On the other hand, some of the FIIs who are in a position to register their clients as sub-accounts have done so, resulting in increased number of sub-accounts, he adds.
Sebi is not comfortable with FIIs managing money for a single individual or a small group of wealthy clients making for a majority of the corpus.
It requires them to have a broad-based fund, which means at least 20 investors with no single individual investor holding more than 49 per cent of the shares or units of the fund. However, if the broad-based fund has institutional investors, it is not necessary for the fund to have 20 investors, according to Sebi norms.
"Additionally, with offshore derivative instruments becoming more onerous and difficult from the know-your-client perspective and other attendant tax uncertainties, investors seem to be preferring direct access through sub-accounts," Shah said.
Tax-related uncertainty due to the proposed GAAR provisions has also resulted in a slowdown in fresh FII registrations with Sebi, experts say. "There is uncertainty about availability of capital gains tax exemptions for FIIs and also the tax treatment of participatory notes issued by them," said Akil Hirani, managing partner at law firm Majumdar and Partners.
After stiff opposition from foreign investors, the government has deferred implementation of GAAR to the next financial year. It has also set up an expert committee to lay down a road map for its implementation.