Who are Foreign Institutional Investors (FII)?

Foreign institutional investors (FIIs) are those investors or funds who make investments in assets located in nations other than their own. The term is most commonly used in India, where it refers to outside entities investing in the nation's financial markets. 

FIIs can include hedge funds, insurance companies, pension funds, investment banks, and mutual funds. FIIs are important sources of capital in developing economies. However, India has placed limits on the total value of assets an FII can purchase and the number of equity shares they can buy.

Developing economies generally provide investors with higher growth potential, as compared to developed economies. Since our country has a high economic growth rate and many fundamentally strong companies to invest in, you can find many active FIIs here. All FIIs in India must register with the Securities and Exchange Board of India (SEBI) to participate in the market.

You can find a list of prominent FIIs here.

Types of Foreign Institutional Investors

Here are the few types of foreign institutional investors in India:

• Pension funds
• Investment trusts
• Banks
• Mutual Funds
• Endowments
• Sovereign Wealth Funds
• Foreign Central Banks
• Asset Management Company
• Insurance/Reinsurance Companies
• Foreign Government Agencies
• Foundations
• University Funds
• Charitable Trusts

Role of FIIs in the Indian Market:

Foreign Institutional Investors (FIIs) play a vital role in driving economic growth, and this holds true for India as well. With their considerable resources and extensive knowledge, these international entities have greatly contributed to enhancing the value of the Indian market. Their main roles include: 

• FIIs play a crucial role in boosting capital/stock markets because they not only contribute funds but also have access and expertise around the globe.
• Their investments improve market liquidity, efficiency, and confidence, which in turn attracts additional investment.
• FIIs allow domestic investors (including institutional and individual investors) to diversify their portfolios by providing access to a broader range of international investment opportunities. 
• Additionally, FII investments have reduced the cost of capital, making it simple to obtain affordable international credit and promoting the economy of the nation.
• FII investments often involve converting foreign currency into local currency. This creates demand for the Indian rupee and affects the country's foreign exchange reserves, exchange rates, and balance of payments.

Regulations for FIIs in India

The Indian govt allows FIIs to invest in its primary and secondary capital markets only through the country's portfolio investment scheme. This scheme allows FIIs to purchase shares and debentures of Indian companies on the nation's stock exchanges. Let us look at some of SEBI’s current regulations on FIIs.

• The eligible categories of FIIs can now include university funds, endowments, foundations, charitable trusts, and charitable societies that have a track record of 5 years. All these entities must register themselves with a statutory authority in their country of incorporation.

• Each FII (or sub-account of an FII) can invest up to 10% of the equity of any one company. The overall limit on investments by all FIIs, Non-Resident Indians (NRIs), and Overseas Corporate Bodies (OCBs) has been set at 24%. This limit can be raised to 30% if a company obtains shareholder approval for the same.

• FIIs can invest in unlisted securities. [An unlisted security is any financial instrument that is not traded on a stock exchange]. Unlisted securities are traded on the over-the-counter (OTC) market (where assets are traded directly between two parties).

• FIIs are allowed to invest in proprietary funds. Proprietary funds are used to account for a government's ongoing organizations and activities that are similar to those found in the private sector.

• FIIs who obtain specific approval from SEBI can invest up to 100% of their portfolios in debt securities (bonds, debentures, etc). Such investment may be in listed debt securities or dated government securities. It is treated to be part of the overall limit on external commercial borrowing.

What are the Disadvantages of FIIs?

• The economy could experience inflation due to portfolio investment. There can be high demand for local currency due to a significant inflow of foreign institutional investment. As a result, the central bank (RBI) will have to release more money into the economy, increasing money flow and setting the stage for inflation.

• When FIIs pour a huge amount into a country, they raise the demand for local currency, causing the domestic currency to become stronger. This makes exports expensive and less appealing in the global market, hurting demand and significantly affecting exports.

• FIIs occasionally solely look for immediate gains. When they pull their investments, banks could face a shortage of funds.

What are Participatory Notes?

A Participatory Note, often referred to as P-Note or PN, represents a financial instrument issued by a registered foreign institutional investor (FII) to cater to overseas investors or hedge funds who wish to participate in the Indian stock markets. The overseas investors need not register themselves with SEBI. Using PNs, financial institutions in a country invest in securities of another country on behalf of their clients. Any capital gains and dividends accumulated through these PNs will go into the hands of clients. It's worth noting that the majority of these 'clients' primarily consist of individual investors.

P-Notes provide quicker means of raising funds for the benefit of listed companies. Foreign investors can easily infuse funds into Indian securities, as they do not have to go through the hassles of government regulations. In fact, the guidelines set by SEBI for investments through PNs are very minimal. These small foreign investors can also remain anonymous.

Concerns over P-Notes:

Various government agencies and financial analysts have stated that this method could be misused by wealthy Indians. P-Notes can potentially be used to bring in significant volumes of foreign unaccounted funds and manipulate stock prices. It can be difficult to track the parties involved in the diversion or misappropriation of these funds. Thus, SEBI began to tighten restrictions and even imposed a ban on PNs in October 2007. This led to the Sensex dropping nearly 8% or 1,744 points on a single day! However, all restrictions were lifted due to concerns about capital outflows during the global financial crisis in 2008. Due to fears of a major market crash, the government is reluctant to introduce a proper ban on participatory notes.

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