Under the existing exchange control regulations, various entry options are available to foreign investors interested in India. Two prominent routes are foreign direct investment (FDI) and the Portfolio Investment Scheme (PIS). The main difference between the two is that under PIS, the purchase of shares and convertible debentures of an Indian company is made through a registered broker on a recognized stock exchange in India, whereas for FDI, “direct investment” is made in a company by subscription to and/or acquisition of its shares/convertible debentures.
At present, the PIS route is open to non-resident Indians and foreign institutional investors (FIIs) registered with the Securities and Exchange Board of India (SEBI). FIIs include asset management companies, pension funds, mutual funds, investment trusts as nominee companies, incorporated/ institutional portfolio managers and their power-of-attorney holders. An FII can invest in both listed as well as unlisted securities as per SEBI (FII) Regulations, 1995. If an FII avails of the PIS to make investments in listed securities through a stock exchange, then it does not require any further permission from the Reserve Bank of India (RBI), whereas the FDI route envisages additional stipulations and conditions.
The distinction between FDI and PIS assumes special relevance with respect to foreign investment in the real estate sector, in light of the provisions of Press Note 2, issued by the Union government on 3 March 2005. The note permits FDI up to 100% under the automatic route in the real estate sector, subject to compliance with requirements relating to, among others, minimum capitalization norms, lock-in of foreign investment, minimum area to be developed and minimum level of development to be achieved within a stated time frame.
The main implication of the note is that FDI in real estate can be undertaken only for projects that comply with the specified requirements. On the other hand, investments through the non-FDI route do not need to comply with the note’s requirements. In other words, the distinction between the character of the foreign investment (whether FDI or non-FDI) is significant in the real estate sector, since FDI in real estate is subject to several conditions and stipulations.
Some recent clarifications issued by the Union government through the Department of Industrial Policy and Promotion (DIPP) indicate that allotment of shares to FIIs by a real estate company through pre-IPO private placements as well as in an IPO, would be treated as non-FDI. Accordingly, such investments would not be subject to the conditions of Press Note 2. Thus, such investments would be permitted even for “non-compliant real estate projects”.
It is pertinent to note that the DIPP has not issued any note or press release on the issue. However, recent reports indicate that the RBI has not concurred with DIPP’s view. The RBI has said investments in real estate companies through private placement of equity shares would be regarded as FDI and would not be given a relaxation from the guidelines as specified in Press Note 2. The real issue, opines the RBI, is that while investments in an IPO may not be subject to FDI norms since they are “market determined”, a private placement of shares in a pre-IPO would be treated as FDI since it is either strategic or negotiated, and takes place as a private deal at a negotiated price.
Therefore, the RBI and the DIPP seem to have different positions on applicability of Press Note 2 to foreign investments brought in by FIIs under pre-IPO placements of real estate companies. The DIPP’s clarifications pave the way for adding greater liquidity to the real estate market through private placements to FIIs. But the clarifications, technically, are a departure from the existing regime wherein FIIs can invest in real estate companies under the PIS route through purchase of shares through recognized brokers on recognised stock exchanges in India.
Whether or not DIPP’s clarifications will prove to be a welcome development for foreign investments in real estate companies is still an open issue, given the divergent views currently taken by the regulators. It appears that DIPP is now seeking Cabinet approval to clarify the question of whether investment by FIIs in the real estate sector through a pre-IPO private placement should be treated as an investments brought in through the non-FDI route. A final verdict is eagerly awaited by different players in the real estate market, not to mention the legal community.
(This column is contributed by AZB and Partners, Advocates and Solicitors. Your comments are welcome at firstname.lastname@example.org.)