RBI, under section 6(3)(c) of FEMA 1999, has the power to prohibit, restrict or regulate the transfer or issue of any security or foreign security by any branch, office or agency in India of a person resident outside India. In furtherance of this power, RBI has framed the FEMA (Transfer or Issue of any Foreign Security) Regulations, 2004 for regulating the issuance and transfer of foreign securities. RBI through its circulars dated, April 30, 2007 and May 04, 2007, had permitted Venture Capital Funds (VCFs), registered with SEBI to invest in equity and equity-linked instruments of off-shore venture capital undertakings, subject to an overall limit of USD 500 million with the prior approval of SEBI. With the SEBI (VCF) Regulations, 1996 now repealed, new VCFs are required to be registered with SEBI as Category I AIFs under the SEBI (AIF) Regulations, 2012. Regulation 15(a) of the AIF Regulations permits AIFs to invest in foreign securities; however, until now, there was no provision in the FEMA (Transfer or Issue of any Foreign Security) Regulations, 2004 enabling AIFs to invest in securities issued by foreign entities.
Recently, RBI, through its circular dated December 09, 2014, has permitted AIFs to invest in equity and equity-linked instruments of off-shore venture capital undertakings, subject to an overall limit of USD 500 million with the prior approval of SEBI. However, the latest circular appears to be a mere reproduction of the permission that was granted to VCFs in 2007.
This raises several concerns. First, the scope of investments by AIFs is much broader than that of the erstwhile VCFs; AIFs include infrastructure funds, private equity funds, hedge funds, etc. Therefore, restricting foreign investments of such funds only to off-shore venture capital undertakings seems illogical; second, an overall investment limit of USD 500 million is excessively small for a class of investment funds, i.e. AIFs, which is much larger in scope than the erstwhile VCFs; third, the RBI notification prescribes a requirement of obtaining the prior approval of SEBI before AIFs invest in securities of off-shore venture capital undertakings. In light of Regulation 15(a) of the AIF Regulations and in view of SEBI’s regulatory responsibility, such a prior approval may lead to unnecessary delays. As regards the apportioning of the overall limit, it may be done on a first-come, first-served basis; and fourth, there is no clear definition of an “off-shore venture capital undertaking” under the AIF Regulations.
A revised notification addressing the aforementioned concerns and highlighting the regulatory rationale may be helpful in providing certainty to AIFs which are considering investing abroad.