Foreign Institutional Investor (FII) means an institution established or incorporated outside India which proposes to make investment in securities in India. They are registered as FIIs in accordance with Section 2 (f) of the SEBI (FII) Regulations 1995. FIIs are allowed to subscribe to new securities or trade in already issued securities. This is just one form of foreign investments in India, as may be seen here.

However, FII as a category does not exist now. It was decided to create a new investor class called Foreign Portfolio Investor (FPI) by merging the existing three investor classes viz. FIIs, Sub Accounts and Qualified Foreign Investors. Accordingly, SEBI (Foreign Portfolio Investors) Regulations, 2014 were notified on January 07, 2014 followed by certain other enabling notifications by Ministry of Finance and RBI. In order to ensure the seamless transition from FII regime to FPI regime, it was decided to commence the FPI regime with effect from June 1, 2014 so that the requisites systems and procedures are in place before migration to the new FPI regime.

With the new FPI regime, which has commenced from 1 June 2014, it has now been decided to dispense with the mandatory requirement of direct registration with SEBI and a risk based verification approach has been adopted to smoothen the entry of foreign investors into the Indian securities market.

FPIs have been made equivalent to FIIs from the tax perspective, vide central government notification dated 22nd January 2014.

FII Vs FDI: International standards and Indian definition

According to IMF and OECD definitions, the acquisition of at least ten percent of the ordinary shares or voting power in a public or private enterprise by non-resident investors makes it eligible to be categorized as foreign direct investment (FDI). (see OECD benchmark definition ) In India, a particular FII is allowed to invest upto 10% of the paid up capital of a company, which implies that any investment above 10% will be construed as FDI, though officially such a definition does not exist. However, it may be noted that there is no minimum amount of capital to be brought in by the foreign direct investor to get the same categorised as FDI.

Given this backdrop, in the Union Budget 2013-14, announced on 28 February 2013, vide para 95, Honourable FM announced his intention to go by the internationally accepted definition for FIIs and FDIs, as stated below:

In order to remove the ambiguity that prevails on what is Foreign Direct Investment (FDI) and what is Foreign Institutional Investment (FII), it is proposed to follow the international practice and lay down a broad principle that, where an investor has a stake of 10 percent or less in a company, it will be treated as FII and, where an investor has a stake of more than 10 percent, it will be treated as FDI. A committee will be constituted to examine the application of the principle and to work out the details expeditiously.

Meanwhile, to rationalize/harmonize various foreign portfolio investment windows and to simplify procedures, SEBI had formed a “Committee on Rationalization of Investment Routes and Monitoring of Foreign Portfolio Investments” under the chairmanship of Shri K. M. Chandrasekhar, former Cabinet Secretary. The Committee submitted its report on June 12, 2013.

In accordance with the budget announcement, a committee has been constituted under the chairmanship of Secy (DEA), to examine and work out the details of the application of the principle followed internationally for defining FDI and FII. The committee submitted its report in June 2014.

rbi.org.in/Scripts/BS_FemaNotifications.aspx )

Myths about FIIs

There are certain myths / beliefs about FIIs which are not necessarily true.

Myth -1 :- FIIs do not invest in unlisted entities. They participate only through stock exchanges

Myth -2 :- FIIs cannot invest at the time of initial allotment. Foreign investors investing in initial allotment of shares (say IPOs or when a group of entities come together to float a company) are categorized as FDIs

Truth on 1 and 2 :- As per Section 15 (1) (a) of the SEBI FII Regulations, 1995, a Foreign Institutional Investor (FII) may invest in the 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. In fact FIIs are very active in the over the counter (OTC) markets and in the IPO market in India.

Myth 3 :- FDI has more direct involvement in technology, management etc while FIIs are interested in capital gain and momentary price differences. Generally direct investment involves a lasting interest in the management of an enterprise and includes reinvestment of profits. In contrast, FIIs do not generally influence the management of the enterprise.

Truth on 3 :- To some extant this notion is true and is emphasized in policy documents. For instance, consolidated FDI Policy of Department of Industrial Policy and Promotion (DIPP) states that “foreign Direct Investment, as distinguished from portfolio investment (FII), has the connotation of establishing a ‘lasting interest’ in an enterprise that is resident in an economy other than that of the investor”.

However, of late, there have been occasions where FIIs come together to influence decisions in companies where they hold shares. The difference between FDI and FII, except for the fact that the latter necessarily has to be an institution (FDI can come from an individual also), rather lies in the registration or approval process and to some extent in the individual investment limits or lock-in conditions specified for each category.

Globally also, the acquisition of at least ten percent of the ordinary shares or voting power in a public or private enterprise by non-resident investors makes it eligible to be categorized as FDI, rather than the purpose of the investments, as intimated or stated by the investing foreigner due to difficulty in assessing it and also for statistical consistency.

Regulation of FIIs

The regulations for foreign investment in India have been framed by the Reserve Bank of India in terms of Sections 6 and 47 of the Foreign Exchange Management Act, 1999 and notified vide Notification No. FEMA 20/ 2000-RB dated 3rd May 2000 viz. Foreign Exchange Management (Transfer or issue of Security by a person Resident outside India) Regulations 2000. as amended from time to time. In line with the said regulations, since 2003, the Securities and Exchange Board of India (SEBI) has been registering FIIs and monitoring investments made by them through the portfolio investment route under the SEBI (FII) regulations 1995. SEBI acts as the nodal point in the registration of FIIs.

Who can get registered as FII?

Following foreign entities / funds are eligible to get registered as FII:

1. Pension Funds

2. Mutual Funds
3. Investment Trusts
4. Banks
5. Insurance Companies / Reinsurance Company
6. Foreign Central Banks
7. Foreign Governmental Agencies
8. Sovereign Wealth Funds
9. International/ Multilateral organization/ agency
10. University Funds (Serving public interests)
11. Endowments (Serving public interests)
12. Foundations (Serving public interests)
13. Charitable Trusts / Charitable Societies (Serving public interests)

Thus it may be seen that sovereign wealth funds (SWFs) are also regulated under FII regulations only, and no separate regulation exists for SWFs. Further, following entities proposing to invest on behalf of broad based funds. are also eligible to be registered as FIIs:

1. Asset Management Companies
2. Investment Manager/Advisor
3. Institutional Portfolio Managers
4. Trustee of a Trust
5. Bank

Foreign individuals can register as sub-accounts of FII to make investments in Indian securities.

What FIIs can do?

A Foreign Institutional Investor may 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 recognised stock exchange in India; and
2. units of schemes floated by domestic mutual funds including Unit Trust of India, whether listed on a recognised stock exchange or not
3. units of scheme floated by a collective investment scheme
4. dated Government Securities
5. derivatives traded on a recognised stock exchange
6. commercial paper
7. Security receipts
8. Indian Depository Receipt

FIIs are allowed to trade in all exchange traded derivative contracts 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, at the end of each trading day.

How do they invest?

A SEBI registered FII (as per Schedules 2 of Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations 2000) can invest/trade through a registered broker in the capital of Indian Companies on recognised Indian Stock Exchanges. FIIs can purchase shares / convertible debentures either through private placement or through offer for sale.

An FII can also invest in India on behalf of a sub-account (means any person outside India on whose behalf investments are proposed to be made in India by a FII) which is registered as a sub-account under Section 2 (k) of the SEBI (FII) Regulations, 1995.

Also, an FII can issue off-shore derivative instruments (ODIs) to persons who are regulated by an appropriate foreign regulatory authority and after compliance with Know Your Client (KYC) norms.

Every FII/sub-account is required to appoint a domestic Indian custodian to hold in custody its Indian securities. Custodian of Securities is a registered and regulated entity by SEBI. The FII/sub-account is also required to ensure that the domestic custodian it has appointed monitors the investments made by it in India, reports its transactions in securities to SEBI on a daily basis and preserve records of transactions for a specified period. The FII/sub-account is also required to suitably enable the custodian to furnish reports pertaining to its activities, to SEBI, as and when required by SEBI.

Authorized dealer banks (i.e. the bank which is authorized by RBI to deal in foreign currency) can offer forward cover (i.e, to minimize the impact of currency fluctuations, banks offer them the option to sell / purchase foreign currency on a fixed future date at a rate specified today) to FIIs to the extent of total inward remittances of liquidated investments.

FII investment limits

Investment by individual FIIs/ sub-accounts (excluding foreign corporates and individuals) cannot exceed 10 per cent of paid up capital of a company. Investment by foreign corporates or individuals registered as sub accounts of FII cannot exceed 5 per cent of paid up capital. All FIIs and their sub-accounts taken together cannot acquire more than 24 per cent of the paid up capital of an Indian Company. An Indian Company can raise the 24 per cent ceiling to the Sectoral Cap / Statutory Ceiling, as applicable, by passing a resolution by its Board of Directors followed by passing a Special Resolution to that effect by their General Body. The list of such companies who have passed a Special Resolution in this regard can be seen from the RBI website.