16 April 2010 | By: Mohamed Hairul Borhan

Foreign institutional investors (FIIs) will have to follow the rules applicable to portfolio investors even if they are investing through the foreign direct investment route, limiting their ability to acquire big stakes in companies.

The new rule released by the Department of Industrial Policy and Promotion (DIPP) has clarified that an individual FII will not be allowed to pick up more than 10 per cent equity in an Indian company even if it is coming as a foreign direct investor.

“FDI route is long term and more stable form of investment and this policy will restrict the free flow of FDI into the country,” said Punit Shah, leader, financial services tax practice, KPMG.

FIIs can invest in Indian companies through both the portfolio investment route or secondary market purchases and foreign direct investment route. But the policy makes a distinction between portfolio investments by FIIs and foreign direct investment.

Under the portfolio route, FIIs can individually acquire up to 10 per cent equity in an Indian company though the aggregate FII limit is pegged at 24 per cent. The limit can, however, be raised after securing board’s approval in sectors where 100 per cent FDI is allowed.

The DIPP has now clarified that the same rule will apply if FIIs come through the FDI route. They cannot pick up more than 10 per cent stake in a company even if their investments are treated as FDI and that such investment should not be more than 24 per cent of the total equity.

“It is more restrictive as 10 per cent limit is lesser than FDI caps in most sectors”. This also brings the issue of composite foreign investment caps to the fore that the finance ministry has been pitching for,” says Mr Shah.

Under the earlier policy, an individual FII investing through the FDI scheme route could pick up to 100 per cent in such a sector. This will impact investments through preferential route or private placements to foreign investors. FIIs will not be able to pick up substantial equity in Indian companies through preferential allotment.

“Regarding FII investments in India, companies could have FII investments up to 49 per cent or the FDI limit after obtaining shareholder approval. However, this point has not been mentioned in the DIPP circular, and one interpretation can be that the FII limit in an Indian company is now capped at 24 per cent,” says Akil Hirani, Managing Partner, Majmudar & Co.

Courtesy of IBEF