New Fema rules stump foreign-owned MFs

Market watchers believe that the change in guidelines fly in the face of some of the recent initiatives taken by the government, such as easing norms for foreign portfolio investors.

Illustration: Uttam Ghosh/Rediff.com

Foreign-owned or controlled mutual funds plan to approach market regulator Securities and Exchange Board of India (Sebi) after being stumped by the tweak in the Foreign Exchange Management Act (FEMA) guidelines, notified a few days ago.

The Association of Mutual Funds in India (Amfi), an industry body, is likely to take up the issue with Sebi on behalf of these fund houses, said people in the know.

The fund houses are likely to make separate representations to the Department of Economic Affairs and the Reserve Bank of India, post consultations with Sebi.

“We will have to knock on every door,” said a senior fund official on condition of anonymity.

“We have reached out to like-minded fund houses and will seek Sebi’s assistance.

"Eventually, the finance ministry would have to take a call.”

In the meantime, individual fund houses are consulting legal advisors to get a hand on the issue and assess the extent of the impact.

“Everybody is still trying to understand what the issue is. If this is the law of the land, what needs to be done to ensure we are compliant?" said another senior fund official.

Market watchers believe that the change in guidelines fly in the face of some of the recent initiatives taken by the government, such as easing norms for foreign portfolio investors (FPIs).

“When regulations for foreign investors are being made easier, the government is introducing constraints on investments by mutual funds that cater predominantly to domestic investors.

"What is the point of introducing caps just because the manager is foreign?” said the second official.

“Technically, the FDI regime does not apply to broad-based portfolio investments, even to those coming from outside India.

"It is applied to investments such as those made for a joint venture or for buying a company.

"Investments from a domestic broad-based mutual fund to get classified as an FDI is a misstep that needs to be resolved quickly,” added the first official.

On October 17, the Centre notified new rules with regard to foreign investment in non-debt instruments, classifying mutual funds that invest more than 50 per cent in equity as ‘investment vehicles’.

Downstream investment by such funds by way of subscription or acquisition of shares will be considered as ‘indirect foreign investment’ if their investment manager or sponsor is owned or controlled by a non-resident.

It is unclear how the 50 per cent in equity criteria will be arrived at for the purpose of classifying funds as investment vehicles.

It is likely that the overall investment in equity across all schemes will be taken to compute the equity portion, said experts.

As of today, Mirae Asset and Principal MF are the two foreign fund houses with equity assets in excess of 50 per cent of the overall portfolio.

“The equity percentage could fluctuate depending on market movement.

"Today, I could be under the FPI regime and tomorrow I may not,” said the first official.

Nippon India MF, Franklin Templeton, Mirae Asset, Invesco and BNP Paribas are some of the foreign fund houses.

HDFC Mutual Fund and ICICI Prudential MF may also be considered to be foreign-controlled or owned under FEMA.

Such funds will have to adhere to the sectoral caps and restrictions applicable to foreign investment in Indian equities.

This could put them at a significant disadvantage vis-à-vis domestic funds, limiting their investments in stocks and dragging down overall returns, said experts.

The restrictions may also make it impossible for their exchange traded funds (ETFs) to invest according to the assigned weightage of the underlying benchmarks.

It may put brakes on fresh money coming into their fund schemes, which invest in other mutual fund schemes, typically international funds.