SEBI-Proposes-Reforms-to-Regulatory-Framework-for-Foreign-Venture-Capital-Investors

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10 Jun 2023

SEBI-Proposes-Reforms-to-Regulatory-Framework-for-Foreign-Venture-Capital-Investors

SEBI Proposes Reforms to Regulatory Framework for Foreign Venture Capital Investors: An Overview of the Proposals

Objective

The objective of this consultation is to gather feedback and suggestions from stakeholders and the general public regarding the simplification of the regulatory framework for the registration of Foreign Venture Capital Investors (FVCIs) under the Securities and Exchange Board of India (Foreign Venture Capital Investor) Regulations, 2000 (FVCI Regulations).

Background

The FVCI Regulations were introduced in 2000 to regulate the investment activities of foreign investors who primarily invest in unlisted securities of Venture Capital Undertakings and Venture Capital Funds (VCFs) registered under the former SEBI (Venture Capital Funds) Regulations, 1996. With the introduction of regulatory frameworks for Alternative Investment Funds (AIFs), FVCIs were also allowed to invest in Category I AIFs.

As of March 31, 2023, a total of 269 FVCIs are registered with SEBI. According to the investment data reported by FVCIs, their cumulative investments in investee companies amount to INR 48,286 Crore.

According to the FVCI Regulations, FVCIs are required to invest at least 66.67% of their investable funds in unlisted equity shares or equity-linked instruments of venture capital undertakings or investee companies. Additionally, not more than 33.33% of investable funds can be invested in various ways, such as subscription to initial public offers, debt instruments of previously invested companies, preferential allotment of equity shares, investment in financially weak listed companies, or special purpose vehicles. FVCIs can also invest their committed funds in a single Venture Capital Fund or Alternative Investment Fund.

Furthermore, investments by FVCIs are governed by the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 (NDI Rules). These rules allow FVCIs to purchase securities issued by Indian companies operating in specific sectors, units of Venture Capital Funds or Category I Alternative Investment Funds, equity or debt instruments issued by Indian startups, and securities listed on recognized stock exchanges, subject to the provisions of the FVCI Regulations.

The FVCI route was introduced to incentivize funding and investments in emerging sectors and early-stage startups. To encourage such investments, certain benefits and exemptions have been granted to FVCIs. These include exemptions from entry and exit pricing norms, non-applicability of open offer provisions, exemption from lock-in requirements, classification as Qualified Institutional Buyers, and the applicability of more beneficial provisions of the Income Tax Act for FVCIs.

It is worth noting that SEBI also registers Foreign Portfolio Investors (FPIs) under the SEBI (Foreign Portfolio Investors) Regulations, 2019 (FPI Regulations) and regulates investments made through the Foreign Portfolio Investment route, primarily in listed securities.

Considering that FVCIs are an avenue for foreign investment in India and that they have been provided certain benefits to encourage investments in emerging sectors and startups, it is necessary to review the eligibility criteria and registration process for FVCIs. This will ensure adequate due diligence and safeguards for regulating investments through this route, similar to those prescribed for other foreign investment avenues. Therefore, aligning the regulatory framework for FVCIs with that of FPIs is deemed necessary.

Proposed Changes to Eligibility Criteria for FVCIs
1. The applicant can be any entity incorporated outside India or in an International Financial Services Centre (IFSC).
2. Non-resident Indians (NRI), Overseas Citizens of India (OCI), or Resident Indian Individuals can be part of the applicant, but their total contribution in the applicant's corpus should not exceed 50%. Additionally, no single NRI/OCI/RI should contribute more than 25%, and they should not have control over the applicant.
3. Resident Indians (other than individuals) can also be part of the applicant if they meet certain conditions, such as being eligible fund managers as per the Income Tax Act or sponsors/managers of an AIF set up in International Financial Services Centres. Their contribution should be within specified limits based on the category of the AIF.
4. The applicant should be a resident of a country whose securities market regulator is a signatory to the International Organization of Securities Commission's Multilateral Memorandum of Understanding or has a bilateral Memorandum of Understanding with SEBI.
5. Government or Government-related investors can be eligible for registration if approved by the Government of India.
6. Banks applying as applicants should be residents of countries whose central banks are members of the Bank for International Settlements.
7. Applicants or their underlying investors contributing 25% or more in the applicant's corpus should not be on the Sanctions List of the United Nations Security Council. They should also not be residents of countries identified by the Financial Action Task Force as having strategic Anti-Money Laundering or Combating the Financing of Terrorism deficiencies.
8. The applicant should have authorization in its incorporation documents or through a resolution to act as a foreign venture capital investor.
9. The applicant should not have been previously denied a certificate by SEBI.
10. The applicant should be considered a fit and proper person based on the criteria specified in Schedule II of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008.

Review of Application Form for FVCIs
- Form A under the First Schedule of FVCI Regulations should be revised to collect information in line with the Common Application Form (CAF) for FPI registration.
- PAN and demat account requirements should be mandatory for FVCI registration.

Dematerialization of Assets of FVCIs
- FVCIs should hold their investments only in dematerialized form, except for investments where dematerialization is not available.
- Existing investments of FVCIs in investee companies where the FVCI or FVCIs have controlling interest should be dematerialized within six months.
- Views sought on mandating dematerialization of existing investments within 12 months for cases where FVCIs do not have controlling interest and whether such investments should be exempt from the dematerialization requirement.

Renewal of Registration of FVCIs
- Introduce a renewal fee of USD 2500 for FVCIs to continue their registration for the subsequent five years.
- If an FVCI fails to pay the renewal fee, a late fee of two percent of the registration fee will be charged.

These proposed changes aim to simplify the registration process for FVCIs, align it with the regulations for FPIs, and enhance transparency and efficiency in foreign investments in India's emerging sectors and startups. The consultation process allows stakeholders and the public to provide feedback and suggestions to shape the legislation in governed manner.

Article Compiled by:-

Mayank Garg

(LegalMantra.net Team)

+91 9582627751

Disclaimer: Every effort has been made to avoid errors or omissions in this material in spite of this, errors may creep in. Any mistake, error or discrepancy noted may be brought to our notice which shall be taken care of in the next edition In no event the author shall be liable for any direct indirect, special or incidental damage resulting from or arising out of or in connection with the use of this information Many sources have been considered including newspapers, Journals, Bare Acts, Case Materials , Charted Secretary etc.