Who are Foreign Institutional Investors (FII)?

Foreign institutional investors (FIIs) are those investors or funds that are based out of a foreign country and invest in the securities market of other countries. 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. This is a major reason why FIIs are commonly found in India, as it has a high economic growth rate and many fundamentally strong companies to invest in. 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, from RBI.

Regulations for FIIs

FIIs are allowed to invest in India's 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 which have a track record of 5 years. All these entities must be registered with a statutory authority in their country of incorporation.

• Each FII (or sub-account of an FII) has been permitted to 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 may be raised to 30% if a company obtains shareholder approval for the same.

• FIIs have been permitted to invest in unlisted securities. [An unlisted security is any financial instrument that is not traded on a stock exchange] Trading of unlisted securities is done on the over-the-counter (OTC) market and are often called OTC securities.

• FIIs have been 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 Participatory Notes?

A Participatory Note is a financial instrument issued by a registered foreign institutional investor (FII) to overseas investors or hedge funds who wish to invest in Indian stock markets. It is commonly known as P-Note or PN. The overseas investors need not register themselves with the market regulator- 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. A point to be noted is that most of these 'clients' are primarily 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.

However, various government agencies and financial analysts have stated that this method could be misused by wealthy Indians. P-Notes can be used to bring in large amounts of foreign unaccounted funds and rig 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 removed amid fears of 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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