India’s financial services sector has attracted significant interest, both from lawmakers and foreign investors. Liberalization of the sector can be traced back to the early 1990s.

Before October 2016, foreign direct investment (FDI) in the services sector under the automatic route (100% FDI permitted without government approval) was restricted to a list of 18 specific activities, and was also subject to compliance with minimum capitalization norms. This dampened the growth of FDI.

A press note issued by the government on 25 October 2016 (PN 6) opened up all financial services activities regulated by financial regulators in India for 100% FDI under the automatic route, without any minimum capitalization requirements. The rationale was that if an activity was already regulated by the norms of a financial regulator such as the Reserve Bank of India (RBI) or the Securities and Exchange Board of India (SEBI), additional regulations regarding FDI were not needed.

PN 6 further provided that FDI up to 100% would be allowed for financial services activities which were not regulated by a financial regulator, but under the government approval route and subject to minimum capitalization norms where set by the government. These requirements caused little concern as almost all financial service activity in India is regulated by a financial regulator.

In a surprising and perplexing move on 16 April 2018, the Ministry of Finance issued a press release setting out minimum capital requirements for financial services which are unregulated by a financial sector regulator, and further setting out what would be construed as an unregulated financial service. The minimum capitalization requirements were set at US$20 million for an unregulated fund-based activity and US$2 million for an unregulated non-fund-based activity.

The press release contained a note explaining that the requirements would cover fund-based and non-fund-based activities to the extent that they are not regulated by any financial sector regulator, including where the entity is not registered with the concerned sector regulator and/or the activity is exempted from registration under the concerned sector regulations. Certain activities are categorized as fund-based and non-fund-based, but the lists are not exhaustive, leaving it open to the government to cover any financial activity within their ambit.

The explanatory note has thrown the financial services sector into a tizzy, as now, to benefit from PN 6, a financial entity not only has to be regulated by a financial regulator but also registered with a regulator. If the intent of PN 6 was to distinguish between regulated and unregulated entities and do away with dual regulation, it is hard to fathom the need to distinguish between registered and unregistered (but regulated) entities.

Fund-based financial services activities in India which are exempt from registration with one financial regulator are usually registered with another one. The issue arises when an activity is regulated by a financial sector regulator but is not required to be registered with a regulator. For example, fund managers of alternative investment funds (AIFs) are exempt from registration under the SEBI (Investment Advisers) Regulations, 2013. Therefore, while an AIF must obtain registration under the SEBI (AIF) Regulations, 2012, the manager of an AIF is not required to obtain a separate registration. However, the manager of an AIF is still subject to a host of compliance requirements in terms of the AIF regulations, and cannot be said to be “unregulated”. But, in light of the press release, any FDI in a fund manager of an AIF would fall under the government approval route and attract the minimum capitalization norms.

It seems that the only financial sector entities that could possibly be categorized as both unregulated and unregistered are certain non-fund-based activities such as “financial consultants” and some types of microfinance companies, which provide low levels of credit and are exempt from registration with the RBI. However, considering that these activities are in the form of consultancy services or provide low levels of credit, the government’s intent in imposing minimum capitalization norms and placing them under the government approval route is unclear. Prior to the liberalization under PN 6, investment advisory and financial consultancy activities were under the automatic route subject to compliance with minimum capitalization norms.

Market participants are eagerly awaiting more clarity on the press release. Meanwhile, the majority of financial services activities, which are in any case registered with a financial regulator, can continue to enjoy the liberalization provided under PN 6.SNG & Partners has offices in Delhi, Mumbai, Singapore and Doha. Devyani Dhawan is a principal associate and Mohit Yadav is an associate.

SNG & Partners has offices in Delhi, Mumbai, Singapore and Doha. Devyani Dhawan is a principal associate and Mohit Yadav is an associate.