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Foreign Portfolio Investment

Foreign Portfolio Investors can Invest in Alternate Investment Funds

Foreign Portfolio Investors

Foreign Portfolio Investors (FPIs) are persons registered with the Securities Exchange Board of India (SEBI) who act as an intermediary to make investments in financial assets in India on behalf of Foreign Investors. Whereas an Alternate Investment Fund (AIF) is an investment vehicle that pools private funds from foreign as well as domestic investors. The AIFs make investments as per the defined investment policy and prevalent regulations.  As per the SEBI (Alternative Investment Fund) Regulations of 2012, there are three categories of AIFs. Category I invests majorly in venture capital funds, Category II invests majorly in debt funds and Category III invests only in listed equities and hedge funds.

Investment Limits for Foreign Portfolio Investors introduced by RBI

The RBI has reviewed the norms of FPI investments in the debt market vide circular no. 01 dated 19th April 2022 and provides a limit that not more than 50% of the securities can be allotted in a single debt issuance. In addition to this, no investment in a single corporate bond shall exceed 20% of an FPI’s corporate debt portfolio and an overall portfolio level of short-term investments should not exceed 20% of the total investment. The popularity of FPIs investing in AIFs gained momentum after the issue of this circular by RBI placing restrictions on investments.

Investments by Foreign Portfolio Investors in Category III AIFs

The SEBI has allowed FPIs to invest in Category III AIF. Category III AIF usually invest in hedge funds and primarily in listed or unlisted securities, derivatives and complex or structured products. Up to 25% of the stakes can be invested in category III AIF. This move will promote investment in Indian Securities markets via FPI Route by AIFs set up in International Financial Services Centres (IFSCs).

As per Regulation 21 (1) of the Securities Exchange Board of India (Foreign Portfolio Investors) Regulations, 2019[1], FPIs are allowed to invest in Category III AIF subject to such terms and conditions as prescribed by SEBI from time to time.

What are the conditions required to be fulfilled for FPI to invest in AIF?

  1. Firstly, investment can be made by an FPI only in the funds prescribed in Regulation 20 (1). Clause (e) to regulation 20(1) prescribes that FPI can invest in units of Category III Alternative Investment Funds registered with SEBI.
  2. FPI investors falling under Category III Alternate Investment Funds are allowed to make portfolio investments only in those securities or instruments in which FPIs are allowed to invest. 
  3. Various advantages like the possibility of local borrowing and leveraging, holding an interest-bearing bank account, local fund management, etc. are available to FPIs under Category III Alternate Investment Fund.
  4. The managers of AIF will have to ensure that the FPIs via the AIF route fulfil the eligibility criteria discussed below:
  5. The FPI can be residents Indian other than Individuals.
  6. The FPI should not be a resident of a country whose security market regulator is a signatory to the International Organization of Securities Commission’s MOU or a signatory to a bilateral MOU with SEBI.
  7. SEBI has prescribed that those investors who contribute 25% or more to the corpus should not be persons specified under the Sanctions List notified by the UN Security Council.
  8. The person investing in FPIs via the AIF route should also not be a resident of a country that has been identified in the public statement of a Financial Action Task Force (FATF). The FPI investors should not be from a country that has not taken sufficient steps to address the deficiencies or has not developed an action plan with FATF to address such deficiencies.
  9. In cases where the FPI subsequently fails to meet the specified conditions, then the manager of AIF will not allow any further capital contribution from the investor for making investments until the FPI meets the conditions again.

What is the impact of FPIs via the AIF route?

As the Indian securities market regulator i.e. SEBI has tightened the debt investment rules for offshore entities, the demand for AIF has increased. The debt limits of FPIs were also getting exhausted quickly so the FPIs started considering the AIF structure. Now, Foreign Portfolio Investors are investing in FPIs via AIF Route to make debt investments in India. FPIs via the AIF route exempt offshore investors from the restrictions imposed by the Reserve Bank of India and promotes flexibility to participate in several types of private debt instruments. For investors who have significant exposure in the Indian debt portfolio, long-term FPIs via the AIF route act as a good alternative as the investors have the option to either invest in a scheme of AIF managed by an Indian manager or establish their own AIF. FPIs via the AIF route are also beneficial from the tax perspective as these investments can be routed via category II AIF which enjoys tax ‘pass-through’ status wherein the tax liability is borne by the investor instead of the fund to avoid any leakage. The restrictions were introduced to stall the potential violation of the new RBI norms. Pursuant to the introduction of these restrictions, the consultants and legal experts advice clients to establish a Special Purpose Vehicle (SPV) through AIFs to participate in any debt instrument.

AIFs are Indian entities so any money that is pooled by them is treated as domestic capital if the AIF is owned and controlled by an Indian Manager. In addition, AIFs have less regulatory requirements as they deal with sophisticated and high-net-worth individuals. This ensures lesser investment restrictions, especially in the debt segment. AIFs cater to wealthy investors and the minimum investment required is Rs. 1 crore for a minimum of 3 years. As retail or small-scale investors are not eligible to invest in this fund, the restrictions are liberal. AIFs are also not subject to sectoral restrictions like in mutual funds. 


The introduction of FPIs via the AIF route is relatively a new concept. It is huge potential for growth with the passage of time. This move has been taken by the regulatory authority to develop the corporate bond market and encourage further investments in the debt market. As discussed, FPIs via Category I and II AIFs will benefit from the tax pass-through status accorded to these two categories of AIFs. All in all the move to invest in FPIs via the AIF route is a welcome step.

Also Read: What is Foreign Portfolio Investment (FPI) in India?

Ankita Tiwari

Ankita is an Advocate and has joined Enterslice as a Legal Researcher. Her work focuses on General Civil and Commercial laws, Corporate Taxation Laws, Labour and Employment Laws and Dispute Resolution. She is a law graduate from School of Law, University of Petroleum and Energy Studies. Prior to joining Enterslice, Ankita has the experience of practicing law in Delhi and Odisha.

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