FPI Regulations Permitting Registration of AIFs in IFSC with Resident Sponsors or Managers as FPIs

Ankita Tiwari

13 Apr, 2023

The Securities Exchange Board of India (SEBI) has permitted Alternative Investment Funds (AIF) to be set up in International Financial Services Centre (IFSC) as Foreign Portfolio Investors (FPIs) to make investments in securities listed on Indian stock exchanges or in specific listed or unlisted corporate debt securities of Indian companies. This was done so because entities set up in IFSCs are considered as ‘non-residents’ for the purpose of Indian Foreign Exchange Regulations and the restrictions placed by SEBI and Reserve Bank of India (RBI) on the participation of Indian residents in FPIs are by default applicable to AIFs in IFSC. Considering the fact that the managers/sponsors are resident Indian entities, they are required to make mandatory sponsor commitment to AIF as prescribed under the SEBI (AIF) Regulations, 2012. So it becomes important to keep a check that the restrictions on residents do not collide with the mandatory sponsor commitment requirement under SEBI (AIF) Regulations, 2012^[1] applicable to AIFs in IFSC.

Eligibility Criteria for FPIs permitting registration of AIFs in IFSC

Proviso 2 to Regulation 4 (c) of the SEBI (FPI) Regulations, 2019 which was inserted by way of amendment to the regulations in 2021 w.e.f. 26.10.2021 provides that resident Indians except an Individual may apply for registration in the following conditions, namely:-

1. The applicant should be an AIF set-up in IFSC and is regulated by the IFSC Authority;
2. The applicant who is a resident Indian except for an Individual should be a Sponsor or Manager of the applicant; and
3. The contribution of the applicant shall be as follows:
4. Where the applicant is a Category I or Category II AIF – 2.5% of the corpus of the applicant or USD 7,50,000, whichever is lower; or
5. Where the applicant is Category III AIF – 5% of the corpus of the applicant or USD 15,00,000, whichever is lower.

Regulatory Framework Relating to AIFs in IFSCs

1. Operating guidelines issued in the form of circulars by SEBI time and again govern the AIFs operating in IFSC. The latest circular in this regard is circular no. SEBI/HO/IMD-1/DF6/P/CIR/2021/584 dated 25^th June 2021.
2. The guidelines mandate the manager or sponsor to have a continuing interest in AIF of at least 2.5% of the corpus or USD 7,50,000 whichever is lower in the form of investment in AIF. The continuing interest shall not be by way of waiver of management fees. In addition, the continuing interest in Category III AIF shall not be less than 5% of the corpus or USD 15,00,000 whichever is lower.
3. To facilitate the relocation of funds established or incorporated or registered outside the IFSC, the continuing interest requirement by the Manager or Sponsor has been made voluntary by the International Financial Services Centres Authority (IFSCA).
4. The RBI issued Circular No. 04 dated 12^th May 2021 allowing Indian parties to make sponsor contributions to AIFs set up in IFSC under the “automatic route” after fulfilling certain regulatory conditions according to the laws of the host country jurisdiction which will be treated as an Overseas Direct Investment (ODI). Indian Party as defined under regulation 2(k) of the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations means a company incorporated in India or a statutory body or a partnership firm investing in a Joint Venture or Wholly Owned Subsidiary abroad and may include other entity as may be notified by RBI.
5. Indian Party is also permitted to make investments in an entity outside India carrying out financial services activities subject to the following conditions:
6. It has earned net profit from the financial services activities during the  preceding 3 (three) financial years;
7. For carrying out financial services activities it is registered with the regulatory authority in India;
8. For venturing into the financial sector activity, it has obtained approval from the concerned regulatory authorities both in India and abroad;
9. It has fulfilled the prudential norms relating to capital adequacy as prescribed by the concerned regulatory authority in India.

The rationale behind allowing investments FPIs to register as AIFs in IFSCs

1. RBI has facilitated sponsor contribution by an Indian Party excluding individuals, to AIFs in IFSCs by considering them as ODI under the automatic route. AIFs in IFSC have also been permitted by IFSCA to invest in mutual fund schemes in India.
2. AIFs in which Resident Indians excluding individuals have contributed as sponsors/managers are ineligible to be registered as FPIs. IFSCA considers this restriction to be affecting the growth of AIFs set-up or proposed to be set up in IFSC.
3. Resident Indians who are individuals have been permitted to invest in FPIs as the amount of money that can be remitted abroad by individuals is restricted by the conditions imposed by the Liberalized Remittance Scheme (LRS).
4. Resident Indians except individuals have been permitted to invest in FPI subject to the satisfaction of the following conditions:
5. The FPI should be approved as an eligible fund by CBDT under section 9A of the IT Act, 1961 read with the IT Rules, 1962.
6. Resident Indian except individuals registered with SEBI as Portfolio Managers, Investment Advisors, etc.
7. Maximum ongoing investment should be 5% of the corpus by all Resident Indians including the sponsor or manager of the eligible fund registered as FPI.
8. Resident Indians excluding individuals making sponsor contributions to AIFs in IFSC should comply with Regulation 7 of Notification No. 120/2004-RB dated 7^th July 2004 which ensures that the entities are regulated by the appropriate regulatory authority in India for conducting the financial services activities and must obtain approval for venturing into the financial sector activity from the concerned regulatory authorities in India as well as abroad.
9. Identical safeguards have been provided under section 9A of the IT Act as well as under Foreign Exchange Management (Transfer or Issue of Any Foreign Security) (Amendment) Regulations, 2004. Therefore, to facilitate the growth and functioning of the AIFs in IFSCs, resident Indians other than individuals have been allowed to become sponsors/managers of AIFs in IFSCs registered as FPIs with SEBI after fulfillment of the following conditions:
10. The AIF should be set up in IFSC and regulated by IFSCA;
11. Resident Indians other than individuals should be constituents of AIF as sponsors/managers;
12. Maximum ongoing investment by the sponsor or manager of the AIF registered as FPI should be capped at the minimum continuing interest expected from the sponsor or manager in the AIF.

Conclusion

In summation, amendment to the SEBI (FPI) Regulations aligns the SEBI (FPI) Regulations, 2019 with the RBI Circular to permit AIFs in IFSCs subject to mandatory sponsor contribution from the resident manager or sponsor entities for registration as FPIs. Furthermore, the following points must be kept in mind for registration: i) permission for the ‘automatic route’ is available only for the resident Indian entities to the extent of mandatory sponsor commitment ii) mandatory sponsor commitment by an Indian party to AIFs in IFSC under the ‘automatic route’ should be as per the prescribed RBI Circular.

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