The FVCI Maze
Written by Sarika // February 1, 2011 // Corporate Law and Business // 20 Comments
Realising the crucial role that a flourishing venture capital industry could play in India’s current economic scenario, India started consolidating the industry’s legal and regulatory framework since 2000. India has undoubtedly come a long way in its efforts to attract foreign venture capital investment by introduction of a streamlined regulatory framework and appointment of the Securities and Exchange Board of India (“SEBI”) as the nodal regulator. However, for the degree of risk that this category of foreign investors in India undertake, it has still not managed to gain as much confidence in the eyes of other Indian regulators involved in its regulation, as foreign institutional investors. All of this when, there is evidence of foreign institutional investors fuelling volatility in stock markets and the potential of foreign venture capital investors (“FVCIs”) to contribute to sustained economic growth. The incidence of operational issues for foreign venture capital investors in India continues!
In the effort to address obvious operational issues and keeping in mind the various recommendations made by committees set up in that behalf, many amendments were made to the SEBI (Foreign Venture Capital Investor) Regulations, 2000 (“Regulations”). One of the most striking issues addressed in view of the committee recommendations was permitting FVCIs to freely determine and agree to the purchase and sale price of shares, unlike other foreign investors. Besides, FVCIs are now not required to seek the approval of the Foreign Investment Promotion Board if they intend to invest in a company belonging to the same field as the company in which it invested earlier. Additionally, FVCIs were exempted from lock-in of shares held post listing, if it held the shares in the investee company for 12 months prior to filing of prospectus by the company; and if they decided to exit after listing they would not trigger off the open offer requirements under the takeover code if they sold their shares to the promoters.
Furthermore, through an amendment of the Regulations, FVCIs were permitted to invest in the real estate sector. Due to anomalies in the legal framework and the objections from the Reserve Bank of India (“RBI”), the Government was required to clarify that investment in the real estate sector by FVCIs shall be limited to ‘construction and development’ activity as laid down in Press Note 2 of 2005. RBI was apparently concerned that the advantageous FVCI regime was being misused to make the most out of ‘non-risky’ sectors like the real estate sector. In the process, RBI did not clear as many as 50 applications for FVCI registrations which SEBI had already cleared. The Government too urged upon RBI to clear atleast those applications which did not seek approval for investment in the real estate sector.
While the applications were still impending, another concern of RBI cropped up. This time RBI was concerned about the thin capitalisation of FVCIs. SEBI addressed RBI’s concern regarding thin capitalisation by issuing a circular on July 3, 2009 directing all FVCI applicants to obtain and demonstrate a firm commitment of USD 1 million from investors at the time of the application. In the meantime, RBI had made up its mind to only allow those FVCI applicants who intended to invest in sectors specified in Section 10(23FB) of the Income Tax Act, 1961, to name a few infrastructure, biotechnology, nanotechnology, information technology etc. The apparent reason of linking FVCI approvals with sectors specified in Section 10(23FB) of the Income Tax Act could possibly be that RBI has been professing level playing between FVCIs and domestic venture capital firms for long enough. While FVCIs are free to seek tax benefits either from the tax exemptions granted under Section 10(23FB) or under the double taxation avoidance agreements between the country of incorporation and India, domestic venture capital firms, who undertake as much risk as FVCIs if not more, are entitled to tax benefits for investment in specified sectors alone as per Section 10(23FB).
The woes of FVCIs do not end here; a new challenge has raised its ugly head. After encountering difficulties which are most likely to discourage intending FVCI applicants, FVCIs are now literally forced to exit their investments either through the IPO of the investee companies or sell shares to persons resident in India in a private sale. One of the conditions of registration listed in Regulation 8 of the Regulations requires an FVCI to enter into an arrangement with a designated bank for the purposes of operating a special non‐resident rupee account or a foreign currency account. The Regulations do not require FVCIs to purchase/sell securities through the non-resident rupee or foreign currency account. FEMA regulations in relation to operation of such accounts by FVCIs merely state that RBI would permit them to operate either or both the accounts, while granting approval to the FVCI. FEMA regulations enumerate some of the permitted transactions which an FVCI could carry during its operations; for instance (i) crediting of inward remittance received through normal banking channels or the sale proceeds (net of taxes) of investments and (ii) remitting funds from the foreign currency account or the special non-resident rupee account subject to payment of applicable taxes. None of these regulations clearly mandate FVCIs to deal through the bank accounts maintained in India alone. Further, FVCIs are required to appoint a domestic custodian for holding securities. Such domestic custodians have been entrusted with the responsibilities of monitoring the investments of FVCIs and furnishing periodic reports as well as other information from time to time to SEBI. As a matter of fact, on plenty of occasions domestic custodians and/or designated banks have refused to oblige FVCIs in transfer of securities and consideration between FVCIs and non-resident purchasers outside India. Reason, custodians and designated banks believe that they are answerable to RBI for monitoring inflows and outflows of FVCI investment. There’s been a lot of hearsay involved in banking, financial services and legal circles on this issue for sometime now. In a couple of such transactions where I faced similar issues, I had the opportunity of talking to a couple of banks and a custodian to know what was going on. One of the banks said that a leading private bank was pulled up by RBI sometime back, for permitting a non-resident purchaser to pay consideration outside India into the foreign bank account of the FVCI involved. However, the custodian who shed some light on the discussion said that they indeed permitted transfers from FVCIs to non-resident purchasers. There seems to be lack of uniformity in approach by these facilitators. Ever since, as a matter of fact many custodians and designated banks insist on routing consideration through the Indian bank accounts of the FVCIs. In these circumstances, FVCIs are either suspending their plans or altogether dropping them! What sense would a transaction make where the risk of currency fluctuation is twice involved! If one were to believe the industry sources, what possibly could have made RBI pull up that bank? Monitoring of inflow and outflow of FVCI investment for statistics or payment of taxes by FVCIs? Or is it because the RBI feels that in this manner a foreign direct investor could circumvent the pricing regulations? Under any of the circumstances, proper regulations could have saved the day and the embarrassment.
We have witnessed how failure to envisage growing needs of business, finance and economics, involvement of parallel regulators and their conflicting agenda and lack of proper regulatory framework to cope up with them has cast a shadow on India’s ambitions to become an economic super power. This is not the first occasion on which regulations are either inadequate to cope up with newer situations or utterly confusing. I hope that our regulators do take notice of and remedy the situation soon!
20 Comments on "The FVCI Maze"
Please guide about the major Venture Capital Funds operating in India and whether they do seed financing or not. Thnx in advance.
Hello Karan,
Many thanks for your question. To answer you, many venture capital funds operating in India are involved in seed financing as a part of their investment strategy. While registering, these funds have to disclose their investment strategies to SEBI. However, the supporting documents submitted alongwith the application to SEBI are not available in public domain. Hence, interested parties looking out for seed financiers would need reliable resources for introduction. You may want to look at the list of foreign as well domestic venture capital funds registered with the SEBI at the following link: http://www.sebi.gov.in/Index.jsp?contentDisp=Department&dep_id=3
Trust I have answered your question adequately.
Best,
Sarika
Hi,
I am confused as to the difference between FII, FDI and FVCI.. Could you please help?
I would be grateful.
Thanks!
Dear Ankit,
FII, FDI and FVCI are so to say, investment routes available to foreign investors. FII route is nothing but portfolio investment scheme available to foreign institutional investors like foreign central banks, university funds etc for investment in the secondary market. Foreign corporates and individuals and proprietary funds can invest under this scheme through registered FIIs, upon registration with SEBI. FDI is available to all foreign investors for the primary markets, as long as it complies with the FDI policy and sectoral caps. FVCI again is a special investment route available to foreign registered entities for investment in Indian venture capital undertakings or in Indian venture capital funds, with certain benefits over FDI investors. FVCI investors need to be registered with SEBI in order to avail those benefits. However, all investments routes put together need to be within the sectoral caps provided in the FDI policy and regulations.
Trust that helps.
Regards,
Sarika
Please let me know if there are any specific qualifications/requirements to act as a custodian?
Hello Deepak,
To act as a custodian, SEBI requires intending persons to apply to it for registration under the SEBI (Custodian of Securities) Regulations, 1996, as amended from time to time. It would be quite difficult for me to list out all the qualifications required to act as such here, but may I suggest that you look at Chapter II and other references made therein of the above regulations? You will find it on SEBI’s website in the Demat/Depositories section.
Trust this helps.
Regards,
Sarika
Good and informative trail. For FVCI route, whcih authority shall first be approached for approval, RBI or SEBI? Thanks.
Hello Av,
Thank you. The application form for registration of an FVCI, Form A, is required to be submitted to the SEBI in duplicate in order to enable SEBI to forward one set to the RBI. In a way, it is a single window clearance mechanism for applicants. Trust I have adequately answered your question.
Regards,
Sarika
Hello
When compared to FDI in NBFCs, the FVCI route seems to be immensely popular. Are tax considerations the main reason for this or are there any other aspects?
FVCI route is primarily used to make investments in Venture Capital Funds. Schedule 6 of FEMA 20 provides auto route for such investments without capitalization norms or pricing restrictions. Taxation issues won’t make much difference.
Is Form FC-GPR required to be filed in respect of an FVCI investment in a venture capital undertaking?
We are looking to raise VC funds for a Real Estate Services Firm. However we realize that FDI is not allowed for investment in Real Estate Services. The questions are : 1) Whether FVCI investment is counted as FDI 2) Whether a Domestic VC investment who has raised funds from abroad would also be counted as FDI investment ?
HI,
Can you guide on the process of getting the funds through FVCI route..
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