Previously, RBI had permitted Indian entities to make mandatory sponsor commitment to AIFs in IFSC under the ‘automatic route’
Alternative Investment Funds (“AIFs”) set up in an International Financial Services Centre (“IFSC”) are required to register themselves as Foreign Portfolio Investors (“FPIs”), for being able to invest inter alia in securities listed on Indian stock exchanges or in specific listed or unlisted corporate debt securities of Indian companies. Since entities set up in IFSCs are equivalent to ‘non-residents’ for the purposes of Indian foreign exchange regulations, restrictions placed by Securities Exchange Board of India (“SEBI”) and the Reserve Bank of India (“RBI”) on participation of Indian residents in FPIs are, by default, applicable to AIFs in IFSC. Considering that AIFs may be set up by managers/ sponsors who are resident Indian entities and that the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”), require managers/ sponsors of AIFs to make mandatory sponsor commitment to the AIF, it is imperative that the restrictions on residents investing in FPIs do not conflict with the mandatory sponsor commitment requirements under AIF Regulations, as applicable to AIFs in IFSC.
RBI’s Relaxation for Resident Sponsors of AIFs in IFSC
On May 12, 2021, RBI had released a circular permitting Indian Parties (as defined in regulation 2(k) of the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) (Amendment) Regulations, 2004) to make sponsor contribution to AIFs set up in IFSC under the ‘automatic route’ (“RBI Circular”), subject to meeting certain regulatory conditions. Notably, RBI continues to prescribe that investments of resident individuals in entities in IFSC, made under the ‘Liberalised Remittance Scheme’, should not be invested back to India.
SEBI’s Amendment to FPI Regulations
In a bid to align the eligibility criteria of FPIs under the SEBI (Foreign Portfolio Investor) Regulations, 2019 (“FPI Regulations”), with the RBI Circular, SEBI has recently amended the FPI Regulations to permit AIFs in IFSC, with mandatory sponsor commitment from resident managers/ sponsors (other than individuals), to seek registration as FPIs.
It should be noted that the relaxation prescribed by SEBI is limited to the extent of mandatory sponsor commitment being made by resident managers/ sponsors to AIFs in IFSC seeking registration as FPIs.
Through this amendment to the FPI Regulations, SEBI seems to have aligned the FPI Regulations with the RBI Circular in order to permit AIFs in IFSC, who have received mandatory sponsor contribution from resident managers/ sponsors entities, to seek registration as FPIs. However, the following points must be noted:
- This permission via the ‘automatic route’ is only available for resident Indian entities to the extent of mandatory sponsor commitment, and it does not automatically apply to any amounts over and above the mandatory sponsor commitment amount.
- As per the RBI Circular, an Indian Party may make mandatory sponsor commitment to AIFs in IFSC under the ‘automatic route’, provided it complies with Regulation 7 of the Foreign Exchange Management (Transfer or Issue of Any Foreign Security) (Amendment) Regulations, 2004.
 Mandatory sponsor commitment requirement applicable to AIFs in IFSC is as follows:
- 5% of the corpus of the applicant or US $ 7,50,000, whichever is lower, in case the applicant is a Category I or Category II AIF; or
- 5% of the corpus of the applicant or US $ 1.5 million, whichever is lower, in case the applicant is a Category III AIF.
 ‘Indian Party’ means a company incorporated in India or a body created under an Act of Parliament or a partnership firm registered under the Indian Partnership Act, 1932 making investment in a Joint Venture or Wholly Owned Subsidiary abroad, and includes any other entity in India as may be notified by the Reserve Bank: –
Provided that when more than one such company, body or entity make an investment in the foreign entity, all such companies or bodies or entities shall together constitute the ‘Indian Party’.
 An Indian Party may make investment in an entity outside India engaged in financial services activities:
Provided that the Indian Party
(i) has earned net profit during the preceding three financial years from the financial services activities;
(ii) is registered with the regulatory authority in India for conducting the financial services activities;
(iii) has obtained approval from the concerned regulatory authorities both in India and abroad, for venturing into such financial sector activity;
(iv) has fulfilled the prudential norms relating to capital adequacy as prescribed by the concerned regulatory authority in India.
Any additional investment by an existing JV/WOS or its step down company in the Financial Services Sector shall be made only after complying with the above conditions.