Foreign Direct & Portfolio Investments

1. Foreign Direct & Portfolio Investments
Unit-4
Unit 4: Foreign Direct & Portfolio Investments development in foreign capital flows; Foreign Institutional
Investors, regulations governing FII in India; FDI- Growth of FDI, advantages and disadvantages of FDI to host
and home country, differences between FDI & FII; Foreign portfolio management- Meaning, objectives, benefits
and risks, ADR & GDR.
INTERNATIONAL FINANCIAL MANAGEMENT
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VIPULKUMAR N M
Assistant Professor,
Department of Commerce,
Kristu Jayanti College, Bengaluru

2. Foreign Institutional Investor (FII)
 A foreign institutional investor (FII) is
an investor or investment fund investing in a country outside of the one
in which it is registered or headquartered.
 FIIs can include hedge funds, insurance companies, pension
funds, investment banks, and mutual funds.
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3. HEDGE FUND
A hedge fund is a pooled investment fund that trades in relatively
liquid assets and is able to make extensive use of more complex
trading, portfolio-construction and risk management techniques in
an attempt to improve performance, such as short selling, leverage,
and derivatives
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7. Understanding Foreign Institutional Investors (FIIs)
FIIs can include hedge funds, insurance companies, pension funds, investment
banks, and mutual funds. FIIs can be important sources of capital in developing
economies, yet many developing nations, such as India, have placed limits on the
total value of assets an FII can purchase and the number of equity shares it can
buy, particularly in a single company. This helps limit the influence of FIIs on
individual companies and the nation's financial markets, and the potential damage
that might occur if FIIs fled en masse during a crisis.
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8. Foreign Institutional Investors (FIIs) in India
Some of the countries with the highest volume of foreign institutional
investments are those with developing economies, which generally provide
investors with higher growth potential than mature economies. This is one
reason FIIs are commonly found in India, which has a high-growth
economy and attractive individual corporations to invest in. All FIIs in
India must register with the Securities and Exchange Board of India
(SEBI) to participate in the market.
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9. Example of a Foreign Institutional Investor (FII)
If a mutual fund in the United States sees a high-growth investment
opportunity in an India-listed company, it can take a long position by
purchasing shares in an Indian stock market. This type of arrangement
also benefits private U.S. investors who may not be able to buy Indian
stocks directly. Instead, they can invest in the mutual fund and take part
in the high-growth potential.
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10. Regulations on Investing in Indian Companies
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 public
exchanges. However, there are many regulations. For example, FIIs are generally
limited to a maximum investment of 24% of the paid-up capital of the Indian
company receiving the investment. However, FIIs can invest more than 24% if the
investment is approved by the company's board and a special resolution is passed.
The ceiling on FIIs' investments in Indian public-sector banks is only 20% of the
banks' paid-up capital.
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11. What is the legal framework governing FII in India
The Foreign Institutional Investors are regulated by the Securities and
Exchange Board of India (SEBI) through the SEBI (Foreign
Institutional Investors) Regulations, 1995 along with the Reserve Bank
of India through Regulation 5(2) of the Foreign Exchange Management
Act (FEMA), 1999.
The FIIs have to comply with such special focus regulations and obtain
approval from both the authorities SEBI and RBI to operate which shall
enable them to engage in buying and selling of securities, open foreign
currency, remit, repatriate funds, etc.
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12. Foreign Direct Investment (FDI)
A foreign direct investment (FDI) is an investment made by a firm or
individual in one country into business interests located in another
country. Generally, FDI takes place when an investor establishes
foreign business operations or acquires foreign business assets in a
foreign company. However, FDIs are distinguished from portfolio
investments in which an investor merely purchases equities of foreign-
based companies.
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13. Types of Foreign Direct Investment
Foreign direct investments are commonly categorized as being horizontal, vertical or conglomerate.
 HORIZONTAL DIRECT INVESTMENT refers to the investor establishing the same type of
business operation in a foreign country as it operates in its home country, for example, a cell
phone provider based in the United States opening stores in China.
 VERTICAL INVESTMENT is one in which different but related business activities from the
investor's main business are established or acquired in a foreign country, such as when a
manufacturing company acquires an interest in a foreign company that supplies parts or raw
materials required for the manufacturing company to make its products.
 CONGLOMERATE type of foreign direct investment is one where a company or individual
makes a foreign investment in a business that is unrelated to its existing business in its home
country. Since this type of investment involves entering an industry in which the investor has no
previous experience, it often takes the form of a joint venture with a foreign company already
operating in the industry
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14. HORIZONTAL FDI: under this type of FDI, a business expands its inland operations
to another country. The business undertakes the same activities but in a foreign
country.
VERTICAL FDI: In this case, a business expands into another country by moving to
a different level of the supply chain. Thus business undertakes different activities
overseas but these activities are related to the main business.
CONGLOMERATE FDI: under the type of FDI, a business undertakes unrelated
business activities in a foreign country. This type is uncommon as in involves the
difficulty of penetrating a new country and an entirely new market.
PLATFORM FDI: here, a business expands into another country but the output from
the business is then exported to a third country.
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15. Advantages of FDI
1. Economic Development Stimulation.
Foreign direct investment can stimulate the target country’s economic development, creating a more
conducive environment for you as the investor and benefits for the local industry.
2. Easy International Trade.
Commonly, a country has its own import tariff, and this is one of the reasons why trading with it is
quite difficult. Also, there are industries that usually require their presence in the international
markets to ensure their sales and goals will be completely met. With FDI, all these will be made
easier.
3. Employment and Economic Boost.
Foreign direct investment creates new jobs, as investors build new companies in the target country,
create new opportunities. This leads to an increase in income and more buying power to the people,
which in turn leads to an economic boost.
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16. 4. Development of Human Capital Resources.
One big advantage brought about by FDI is the development of human capital resources, which is also
often understated as it is not immediately apparent. Human capital is the competence and knowledge of
those able to perform labor, more known to us as the workforce. The attributes gained by training and
sharing experience would increase the education and overall human capital of a country. Its resource is
not a tangible asset that is owned by companies, but instead something that is on loan. With this in mind,
a country with FDI can benefit greatly by developing its human resources while maintaining ownership.
5. Tax Incentives.
Parent enterprises would also provide foreign direct investment to get additional expertise, technology
and products. As the foreign investor, you can receive tax incentives that will be highly useful in your
selected field of business.
6. Resource Transfer.
Foreign direct investment will allow resource transfer and other exchanges of knowledge, where various
countries are given access to new technologies and skills.
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Advantages of FDI

17. Disadvantages of FDI
1. Hindrance to Domestic Investment.
As it focuses its resources elsewhere other than the investor’s home country, foreign direct investment can
sometimes hinder domestic investment.
2. Risk from Political Changes.
Because political issues in other countries can instantly change, foreign direct investment is very risky. Plus,
most of the risk factors that you are going to experience are extremely high.
3. Negative Influence on Exchange Rates.
Foreign direct investments can occasionally affect exchange rates to the advantage of one country and the
detriment of another.
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18. 4. Higher Costs.
If you invest in some foreign countries, you might notice that it is more expensive than when
you export goods. So, it is very imperative to prepare sufficient money to set up your
operations.
5. Economic Non-Viability.
Considering that foreign direct investments may be capital-intensive from the point of view of
the investor, it can sometimes be very risky or economically non-viable.
6. Expropriation.
Remember that political changes can also lead to expropriation, which is a scenario where the
government will have control over your property and assets. Expropriation refers to a
government taking over any property that is privately owned, with or without the permission of
the owners, for the benefit of the general public. Properties can be expropriated for the
construction of roadways, airports, and other infrastructure projects.
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Disadvantages of FDI

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22. Legal limitations of FIIs
There are various legal precedents and restrictions on Foreign Institutional
Investors (FII)
 FIIs are generally limited to a maximum investment of 24% of the paid-up
capital of the Indian company receiving the investment. However, FIIs can
invest more than 24% if the investment is approved by the company’s board
and a special resolution is passed. The ceiling on FIIs’ investments in Indian
public-sector banks is only 20% of the banks’ paid-up capital. Although the
24% limit may be raised to 30% in the case of individual companies who have
obtained shareholder approval for the same but not more.
 Any FII or sub-account of an FII has been permitted to invest up to 10% of the
equity of any one company, subject to the overall limit of 24% on investments
by all FIIs, NRIs, and OCBs
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23. 3. While permitting investment, SEBI set prescribed conditions which may be
compulsory concerning the maximum amount which can be invested in the debt
securities by foreign institutional investors on their account and sub-account. An
investment made in securities which are issued by the assets reconstruction
companies or those companies who are under the Security and Reconstruction of
Financial Assets and Enforcement of Security Interest Act, 2002.
4. The Reserve Bank of India monitors compliance with these limits daily by
implementing cutoff points 2% below the maximum investment. This gives it a
chance to caution the Indian company receiving the investment before allowing
the final 2% to be purchased.
5. RBI and SEBI are two authorities to regulate FII but due to different
provision an entirely separate body which comes under RBI and SEBI should be
created to monitor effectively these capital Funds to be created to monitor
compliance to both the regulations given under (Foreign Institutional Investors)
Regulations,1995 and Foreign Exchange Management Act (FEMA), 1999.
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25. Foreign Portfolio Investment (FPI)/ Foreign Portfolio
Management (FPM)
Foreign portfolio investment (FPI) consists of securities and
other financial assets held by investors in another country. It
does not provide the investor with direct ownership of a
company's assets and is relatively liquid depending on the
volatility of the market. Along with foreign direct investment
(FDI), FPI is one of the common ways to invest in an overseas
economy. FDI and FPI are both important sources of funding for
most economies.
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26.  Foreign portfolio investment (FPI) involves holding financial assets from a
country outside of the investor's own.
 FPI holdings can include stocks, ADRs, GDRs, bonds, mutual funds, and
exchange traded funds.
 Along with foreign direct investment (FDI), FPI is one of the common ways
for investors to participate in an overseas economy, especially retail
investors.
 Unlike FDI, FPI consists of passive ownership; investors have no control
over ventures or direct ownership of property or a stake in a company.
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28. How FPI emerged in India?
 In 1992, India opened up its economy and allowed foreign portfolio
investment in its domestic stock market
 Since then ,FPI has emerged as a major source of private capital inflow in
this country
 India is more dependent upon FPI than FDI as a source of foreign
investment.
 During 1992 -2005 more than 50 percent of foreign investment in India
came from FPI.
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29. Major drivers for attracting portfolio
inflows
 Well performing stock market
 Strong economic growth
 Appreciating currency exchange rate
 Domestic output growth of the country
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30. Major factors that discourages the
inflow
 High volatility in the exchange rate
 Performance of stock market in other emerging
countries
 Interest rate - higher the interest rate in domestic
market than foreign market, more the FPI flows and
vice-verse
 Poor output growth of the country
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31. Eligibility Criteria for FPI
 The Applicant:
 Is a person not resident in India
 Is a resident of a country which is a signatory to SEBI MoU/IOSCO’s MMoU
 Is resident of a country meeting FATF (Financial Action Task Force) requirements
 If a Bank, should be resident of a country whose Central Bank is a member of the
Bank for International Settlements
 Is not a Non Resident Indian (NRI)
 Is legally permitted to invest in Securities outside his country
 Has sufficient experience, good track record, is professionally competent, financially
sound, generally good reputation of fairness and integrity
 Does not have a “opaque” structure (protected / segregated cell company or
similar where ultimate beneficial owners are ring fenced from each another)
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32. Mode of FPI Investments
 Foreign Institutional Investments
 Foreign Organization set up to invest in India
 GDRs/ADRs
 Raising money from abroad through issue of shares abroad
 Offshore Funds
 Funds raised outside India to be invested here
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33. FPI Investment Guidelines
RFPI (Registered Foreign Portfolio Investor) may also acquire shares or convertible debentures in any bid for, or
acquisition of, securities in response to an offer for disinvestment of shares made by the Central Government or any
State Government;
or
in any transaction in securities pursuant to an agreement entered into with merchant banker in the process of market
making or subscribing to unsubscribed portion of the issue in accordance with Securities andExchange Board of India
Regulations, 2009 (Issue of Capital and Disclosure Requirements).
The individual and aggregate investment limits for the RFPIs shall be below 10% (per cent) or 24% (per cent)
respectively of the total paid-up equity capital or 10% (per cent) or 24% (per cent) respectively of the paid-up value of
each series of convertible debentures issued by an Indian company.
RFPI shall be eligible to open a Special Non-Resident Rupee (SNRR) account and a foreign currency account with
Authorised Dealer bank and to transfer sums from foreign currency account to SNRR account at the prevailing market
rate for making genuine investments in securities. The Authorised Dealer bank may transfer repatriable proceeds (after
payment of applicable taxes) from SNRR account to foreign currency account ;
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34. FPI Investment Guidelines
 RFPI shall be eligible to invest in government securities and corporate debt
subject to limits specified by the RBI and SEBI from time to time;
 The investment by RFPI will be made subject to the SEBI (FPI) Regulations
2014, modified by SEBI/Government of India from time to time;
 RFPI shall be permitted to trade in all exchange traded derivative contracts
on the stock exchanges in India subject to the position limits as specified by
SEBI from time to time;
 RFPI may offer cash or foreign sovereign securities with AAA rating or
corporate bonds or domestic Government Securities, as collateral to the
recognized Stock Exchanges for their transactions in the cash as well as
derivative segment of the market.
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35. Mode of FPI Investments
 Foreign Institutional Investments
 Foreign Organization set up to invest in India
 GDRs/ADRs
 Raising money from abroad through issue of shares
abroad
 Offshore Funds
 Funds raised outside India to be invested here
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36. ADRs/GDRs
 Stands for American Depository Receipts/Global Depository Receipts
 ADR/GDR provides a path for Indian companies to get listed in foreign stock exchanges
indirectly.
 If an Indian company wants to get listed in foreign stock exchange indirectly then it have to
deposit its shares and securities in a bank of foreign country whose stock exchange the
company wants to list in.
 The receipts are issued by the bank against these securities which are then sold to the
residents of that country.
 The receipts are also listed in the stock exchange of that country which are available for
buy and sell on the stock exchange like other instruments.
 The prices of this receipts are also determined by supply and demands in the market.
 The receipts traded in American market are termed as American Depository Receipts and
the receipts traded in any other country (except America) are called as Global Depository
Receipts.
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37. THE END
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