FDI, FII and International Financial

Management

CA Final Strategic Financial Management,

Paper 2 Chapter 11
CA Tarun Mahajan
Learning Objectives

Foreign Direct Investment

Foreign Institutional Investment

Global Depository Receipts

American Depository Receipts

External Commercial Borrowings

International Finance
International
Finance

Equity Debt

External
Issue Outside
Issue in India Commercial
India
Borrowings

Global
Foreign Direct
Depository Long Term
Investment
Receipts

Foreign American
Institutional Depository Short Term
Investment Receipts
Why International Finance?

An Indian company can raise

fund in India as well as abroad.
A question may be that why
should a company use
overseas fund?
• Supplement Indian fund
• Supplement Indian technology
• Supplement Indian skills
Foreign Direct Investment (FDI)
FDI is when a foreign
company invests in India
directly by setting up a wholly
owned subsidiary or getting
into a joint venture, and
conducting their business in
India.

Thus the foreign company not

only puts money in India but
also provide technology and
skills and also allow its brand
name to be used.
 FDI examples
IBM India is a wholly owned subsidiary of IBM, and is
a good example of FDI where a foreign company has
set up a subsidiary in India. What’s amazing about
IBM is that, it is now the lartest Indian IT company in
India.

Foreign companies partnering with Indian companies

to set up joint ventures is more typical and Starbucks
partnering with Tata Global Beverages Limited is a
recent example of FDI through joint venture, but
there are several others in the insurance, telecom,
food industry etc.
 FDI Entry Routes

FDI entry routes

Automatic Government
route route
Advantages of FDI to host
country
Improves balance of payment position.

Better technology and skills to produce

global standard goods and services.

Increase in employment opportunities.

Increase in Government revenue.

Backward linkage gives rise to development of

supply industries.
Advantages of Joint Venture to
Foreign Investor
India is one of the biggest consumer
market. Size of middle class in India is
more than Population of many countries.

Established Marketing Network of

Indian Partner

Contacts of Indian Partner

Understanding of Indian Partner of Local

market and consumer needs.
Foreign Institutional Investment
(FII)
FII is when foreign investors invest in the shares of
a company that is listed in India, or in bonds offered
by an Indian company or other eligible investment.

Foreign pension funds, mutual funds, banks and

insurance companies are examples of FIIs.

It is a portfolio Investment.
FII sub account and P notes
An FII can also invest in India on behalf of
a sub-account (means any person outside
India on whose behalf investments are
proposed to be made in India by a FII) which
is registered as a sub-account with SEBI.

Also, an FII can issue off-shore derivative

instruments (ODIs) to persons who are
regulated by an appropriate foreign regulatory
authority and after compliance with KYC
norms.
 FII continued…
A single FII can not invest more than 10% in single
company.

Normally FII investment in a company can not be more

than 24%.

The company may allow higher investment but it should

not be more than the sector cap.

FII money is said to be hot money. It suddenly flows in to

and out of the country.

Many time FIIs are blamed for market volatility.

 FII Registration

To make investment in India FII has to register with SEBI.

It has to submit several documents and pay registration

fees around $5000. This registration is valid for five years.

Normally it takes seven days to get registration.

Sub account registration fees is $1000.

 FII: Eligible Securities
Securities in primary and secondary markets including shares,
debentures and warrants of companies, unlisted, listed or to be
listed on a recognized stock exchange in India;

Units of mutual funds;

Dated Government Securities;

Derivatives traded on a recognized stock exchange;

Commercial papers.
 Global Depository Receipts
Indian • Issues rupee denominated
Company shares to

Domestic
• Informs the same to
custodian bank

Overseas
• Issues depository receipts to
depository bank

Foreign • Makes payment to the

investors account of Indian company.
 GDR: exit routes
• GDRs are listed hence it can be
Transfer sold to another investor.

• Investor surrenders GDR to

overseas depository who instructs
Redemption domestic custodian to sale
underlying shares.

• Overseas depository instructs

Conversion domestic custodian to release
shares in favour of investor.
GDR: Benefits to Indian Issuer

Large volume of funds

Attractive price

Continue to control

No exchange rate fluctuation risk

Better image
GDR: Benefits to Investors
Higher return

Portfolio diversification

Easy transferability

Arbitrage Opportunity

No formalities in India

No Capital gain tax

 ADR vs GDR
American Depository Receipts
ADRs are issued in the USA.
ADRs are listed on an
American Stock Exchange, e.g.,
New York Stock Exchange or
NASDAQ.
Disclosure requirements of SEC
are very stringent.
ADR market is mainly a retail
investors market. It leads to
wider participation and better
valuation of a company’s stock.
Global Depository Receipts
GDRs are issued in Europe.
GDRs are listed on any stock
exchanges other than
European stock exchanges,
e.g., London or Luxemburg
stock exchange.
Disclosure requirements for
GDRs are less stringent
GDR market is mainly an
institutional market, with
lower liquidity.
 Types of ADR
ADRs

Unsponsored Sponsored

Restricted Unrestricted

Level 1 Level 2 Level 3

 External Commercial
Borrowings
• ECB is a commercial loan obtained by Indian
corporate from non resident lenders.

• Rate of interest on these loans remains lower than

domestic loans.

• Even after considering forward premium it proves

to be a cheaper source of finance.

• Indian corporate can avail ECB but banks,

financial institutions, Individuals, Trusts and non
profit making organizations are not eligible.
 ECB continued…
It can be obtained from:
• International banks,
• International capital markets,
• Multilateral financial institutions
• Supplier of equipment
• Foreign collaborators
• Foreign equity holders
There are two ways to procure ECB:
• Automatic route
• Approval route
 ECB continued…

• Maximum amount of borrowing for

corporate which are not hotel,
hospital or software units is US$
750 millions p.a.
• For Hotels, hospitals or software
Under units it it US$200 millions p.a.
Automatic • Minimum borrowing period should
route: be 3 years.
• Borrowing cost should not be more
than 6 months Libor + 350 basis
points for loans of 3-5 years.
ECB continued…

• For loans of more than 5 years ceiling is 6

months Libor + 500 basis points
• ECB can be used for Import of capital
goods, New projects, expansion of existing
projects, infrastructure projects etc.
Under
• ECB can not be used investment in capital
Automatic
route: market, real estate, working capital or
repayment of rupee loan.
• Indian banks and financial institutions can
not give guarantee for such loans.
ECB data
• Funds raised through ECB in April, 2013 were $602
million through automatic route and $523 millions through
approval route totalling $1125 millions

• In automatic route Mylan Laboratories Ltd. Alone raised

$200 millions for a period of 6 years and 7 months for
import of capital goods.

• You can see a complete list at

http://www.rbi.org.in/scripts/ECBView.aspx
 Euro Financial Market

When borrower of one country borrows money from

lender of another country in terms of currency of a
third country it is called euro market.

The most popular in this category is euro-dollar

market.

For example Indian company issues dollar

denominated bonds in UK.
 Euro market continues

It may be divided into:

• euro deposit market,
• euro note market,
• euro loan market and
• euro bond market.

Instruments in this market are similar to domestic

or international financial market. For example:
• euro bond,
• euro convertible bonds,
• euro bonds with equity warrants.
Question Time
Nov 2012 exam question
• Write short note on American Depository
Receipts.
(4 marks)
Answer
• An ADR is an instrument that allows Indian
companies to raise funds through equity
issues abroad. It is a dollar denominated
instrument, traded in stock exchanges
outside the country of origin. Though ADRs
are dollar denominated (It means that foreign
investor make payment in terms of $ while
subscribing ADR) but the underlying shares
of Indian company are rupee denominated.
Normally there is one share behind one ADR
but there may be two or more shares behind
one ADR or one share behind two or more
ADRs.
 Lesson Summary
What is the difference between
FDI and FII

Difference between GDR and

ADR

Broad guidelines of External

commercial borrowings

Concept of Euro financial market

 Thank you

CA .Tarun Mahajan
tarunmahajanca@gmail.com