RBI circular limits investment by Mutual Funds & could cause sell-off

According to a press report in the HBL, a new RBI circular on indirect foreign investments in India could cause a sell-off in the stock market.

AMCs majority owned by foreign companies will fall under the "indirect foreign investment" category and be subjected to limits

The RBI has said that asset management companies (AMC) majority owned by foreign companies will fall under the indirect foreign investment category.

The implication is that AMCs like HDFC, ICICI Prudential, Nippon and Axis MF will be subject to a ceiling on the investments they can make in listed companies and sectors in line with the foreign investment rules.

The RBI circular also threatens India’s weight in the MSCI Index, which has billions of dollars worth of fund flows linked to it, as funds will be forced to either refrain from buying into many large companies or even offload their stake, experts said.

Anyway, there is the possibility of a massive sell-off in the market merely on anticipation that funds would have to exit their holdings in large listed companies as the first reporting under the amended Foreign Exchange Management Act (FEMA) guidelines is to be done by the second week of November for the funds.

The RBI circular was issued in the middle of October and draws specific reference to SEBI-registered MFs.

The relevant part of the RBI circular is as follows:

“Investment made by an investment vehicle (like registered FPI) into an Indian entity shall be reckoned as indirect foreign investment for the investee Indian entity if the sponsor or the investment manager is not owned or not controlled by resident Indian or is owned or controlled by resident outside India. Provided that for sponsors or managers or investment managers organised in a form other than companies or LLPs, SEBI will determine if the sponsor or manager or investment manager is foreign-controlle,”

The RBI circular explicitly states that investment vehicles mean MFs that invest more than 50 per cent in equities governed by SEBI regulations 1996 ― simply meaning, all listed stocks.

Cap on foreign direct or indirect investment

In India, FEMA rules specify a cap on foreign direct or indirect investment across sectors. Such investment caps are mainly in the banking sector. Foreign portfolio investors (FPIs), large foreign funds or corporations hold large stakes in Indian AMCs that promote MFs, which so far enjoyed no bar on investment in any listed companies in India. But the RBI now believes that such foreign control of domestic AMCs, which in turn invest in listed Indian companies, violates FEMA rules as it constitutes indirect foreign holding that could be over and above the specified cap.

Investment of 10 per cent or above from overseas is considered as FDI

According to the Organization for Economic Co-operation and Development (OECD), an investment of 10 per cent or above from overseas is considered as FDI. In India, FDI FIIs/FPIs are allowed to invest and trade in equity securities, with a maximum total investment of 24 per cent of the issued and paid-up capital of a company. This limit can be raised up to the prescribed sectoral cap of that particular industry by passing a special resolution to the effect. So, if FPIs put together already hold 24 per cent of the paid-up capital in a company, and even MFs, controlled by foreign players, own stake in that company, then it would be a violation of the RBI’s October 2019 circular. The foreign holding in such a company will have to fall accordingly. It is feared that such a diktat and the short deadline could spark a sell-off in the stock markets, experts said.