Mumbai: The markets regulator has written to the finance ministry over its recent circular tagging foreign-controlled mutual funds as investment vehicles, two people familiar with the matter said. The regulator’s intervention comes amid fears that the new rules could force several equity asset managers to freeze investment activity and even sell their holdings.
The Securities and Exchange Board of India (Sebi) made its representation after mutual funds made their case to the regulator. The anomaly arising from the circular is that retail domestic money invested in the schemes of foreign-owned mutual funds will be counted as foreign money.
“As per the Sebi Act, under all rules and regulations, mutual funds are exempted from all money pooling or investment vehicle provisions. So, the ministry’s view that foreign majority-owned funds are investment or pooling vehicles is in direct contradiction," the first of the two people cited earlier said on condition of anonymity. “This will create unnecessary hurdles for the fund houses if they were to increase their stake in any scrip, which already has foreign investment close to maximum permissible limit under Reserve Bank of India- prescribed threshold."
The 17 October circular under the Foreign Exchange Management Act (FEMA) defined mutual funds with more than 50% foreign shareholding as investment vehicles. This will force them to comply with investment caps under foreign direct investment (FDI) rules. For example, if a company is allowed 74% foreign shareholding under FDI rules, any investment in it by an Indian mutual fund with more than 50% foreign shareholding will be considered part of the 74% cap. Many funds may have to sell their holdings in companies where the overall “foreign holding" has crossed the prescribed cap. So far, only category-III alternative investment funds, real estate investment trusts and infrastructure investment trusts were categorized as investment vehicles.
Some of the fund houses that could be directly impacted by the move are HDFC Mutual Fund, ICICI Prudential Asset Management Co. Ltd and Mirae Asset Mutual Fund, all of which have over 50% foreign ownership.
“We have taken cognizance of the issue and are in dialogue with the finance ministry to resolve the issue at the earliest. The ministry has also understood our concern and may issue a clarification soon," a regulatory official, the second person cited earlier, said on condition of anonymity.
An email sent to Sebi seeking comment on Friday was not answered till press time.
“The recent changes in the law have resulted in investments by some Indian mutual funds in Indian companies being now treated as indirect foreign investment, as against the earlier position of it being treated as Indian domestic investment," said Gautam Mehra, tax and regulatory services leader at PwC India. “Accordingly, additional investments by these mutual funds or other foreign investment would be restricted in investee companies where the permissible level of FDI has been exhausted. Reporting obligations and adherence to pricing norms also follow as a result. It would be useful for stakeholders to fully understand the implications of this change."
Sebi’s communication to the ministry follows multiple representations from asset management companies, which are likely to be impacted by the move. The Association of Mutual Funds in India had also sent a consolidated representation to the markets regulator, said the first person cited earlier.
A senior executive at a foreign-owned fund house said the move unnecessarily favours domestic fund houses.
“Imagine a situation where I decide to invest in a banking stock, but it has already close to 74% foreign investment. So if I do invest in that scrip, I would potentially end up locking out the entire market (foreign investment)," he added.
Despite the concerns, fund houses have so far not tinkered with their portfolio as the regulator has assured them that their concerns would be looked into.
“We, as well as some of the other fund houses potentially impacted by the move, have not changed or altered our portfolios," said the chief executive of a foreign-owned fund. “If this is the law of the land, though highly unfair and may defy logic, we will have to do a major rehaul of our portfolios. The industry is also in talks with consulting firms to guide us in understanding the implications and getting those addressed by the government."