The capital markets of a country play a crucial role in the creation of wealth. Millions of small investors use the capital markets to save and accumulate funds to achieve life goals. However, contrary to popular perception, capital markets do not just attract domestic money. Every year, investors based in foreign countries invest billions of dollars in Indian capital markets. Foreign capital plays an important role in the economy of India. The inflow of foreign capital helps in stabilising the exchange rate and also contributes to the development of countries with limited resources. Every country categorises capital from a foreign country on the basis of the role it plays.

Types of foreign investment

There are various types of foreign investments. Governments classify foreign investors for better regulation and monitoring. Foreign investment can be broadly classified into two—Foreign Direct Investment (FDI) and Foreign Institutional Investor (FII). Any institution incorporated in a foreign country that proposes to invest in Indian securities can be termed as FII. FIIs are allowed to invest in initial public offerings as well as securities that are already trading on the exchanges. There is a difference between FDI and FII. The proportion of ownership in a company decides the classification of foreign investment. As per the internationally-accepted definition, an investment that leads to over 10% ownership of common shares or voting rights is called as FDI. In India, FIIs are allowed to invest up to 10% of the paid capital of a company. The classification of FDI and FII is clarified in Schedule 1 and 2 of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident outside India) Regulations 2000.

Foreign Institutional Investor

After some recent changes brought by the government, a new category of Foreign Portfolio Investor (FPI) which subsumed the FII category. As per the SEBI (Foreign Portfolio Investors) Regulations, 2014, the existing investor classes of FIIs, Sub Accounts and Qualified Foreign Investors were merged to form the FPI category. The FPI regime came into existence from June 1 after all the systems and procedures were put into place. The tax treatment of FPIs is similar to FIIs. Even though officially FIIs do not exist anymore, the terms FPI and FII are used interchangeably.

Types of FII

There are different types of FIIs operating in India. A wide variety of foreign institutions can be categorised as FIIs in India. Here is a list of foreign institutional types investing in India.  

– Pension funds

– Mutual Funds

– Investment trusts

– Banks

– Sovereign Wealth Funds

– Asset Management Company

– Insurance/Reinsurance Companies

– Foreign Central Banks

– Foreign Government Agencies

– Endowments

– Foundations

– University Funds

– Charitable Trusts

Foreign individuals can also invest in Indian markets by registering as sub-accounts of FIIs. While there are different types of FIIs, the government has streamlined the process of investment to make it easier for FIIs to access financial markets in India. To invest in Indian securities, FIIS have to register with the Securities and Exchange Board of India and invest through a registered broker and a recognised stock exchange. Different types of foreign institutional investors can invest in shares or convertible debentures through private placement or offer for sale. FIIs are also allowed to issue Offshore Derivative Instruments to entities regulated by a foreign regulatory authority. The sub-accounts/FIIs have to appoint a local custodian for the Indian securities. The domestic custodian holds the securities in its custody. The local custodian is registered and monitored by the markets regulator. FIIs/subaccounts have to ensure that the local custodian monitors its investments and reports all the transactions at regular intervals.

Conclusion

FIIs stimulate the capital markets and make them more efficient. Different types of FIIs act as a catalyst for the domestic markets and attract capital from other segments of investors. FIIs generally prefer equity over debt, which helps in maintaining and improving the capital structures of domestic companies. FIIs incorporated in countries across the world invest in Indian markets, bringing with them best practices and financial innovation. FIIs are largely beneficial for the domestic markets and companies, but without proper monitoring and regulation, large inflows and outflows can result in increased volatility.