Introduction
The Securities and Exchange Board of India (“SEBI”) recently introduced the Securities and Exchange Board of India (Foreign Venture Capital Investors) (Amendment) Regulations, 2024[1] which seeks to amend the SEBI (Foreign Venture Capital Investors) Regulations, 2000 and shall come into force with effect from January 1, 2025. The objective of the amendment is to address extant regulatory arbitrage between the SEBI regulated foreign investment route, to streamline the regulatory framework for registration of Foreign Venture Capital Investors (“FVCIs”), along with ensuring due diligence in regulating the inflow of foreign capital in India.[2] This article aims to identify the key changes introduced by the amended regulations, analyse their potential impact on stakeholders, and discuss the importance of regulatory compliance in the venture capital eco-system especially at this crucial juncture wherein India is witnessing a significant surge in startup activity and hence the need for foreign capital to fuel innovation and growth is at an all time high.
Background
SEBI has played a crucial role in regulating and facilitating the venture capital funds in India, expanding its scope further to foreign investments as well through the introduction of SEBI (Foreign Venture Capital Investor) Regulations, 2000 (“FVCI Regulations”)[3] enabled FVCIs and private equity investors to register with it. This step played a key role in the liberation of the industry by paving the path of entry to foreign investors in India. The SEBI (Foreign Venture Capital Investors) Regulations, 2000, have been instrumental in providing a framework for foreign venture capitalists to invest in Indian companies. However, as the investment landscape evolves, it becomes necessary to adapt the regulations to meet the changing needs of stakeholders. Hence, SEBI introduced SEBI (Foreign Venture Capital Investors) (Amendment) Regulations, 2024.
Regulations and Regulatory bodies governing Foreign Venture Capital Investment
The landscape of FCVI in India is primarily governed by two major statutes, namely the Foreign Exchange Management Act (FEMA)[4] and SEBI. Regulations which deal specifically with FVC are passed under these acts, and also, from time to time, by RBI. Although FVCIs do not require RBI approval for investments in certain sectors, they must still adhere to the broader Foreign Direct Investment (FDI) policy and regulations under the FEMA.
The foundation for regulation concerning VCs in India was laid down by the SEBI (Venture Capital Funds) Regulations[5] formulated in 1996 which aimed to regulate and necessiatate registration of VCs in the domestic context. This was then followed the SEBI (Foreign Venture Capital Funds) Regulations, 2000[6] that was the first legislation of its kind that dealt with VCs in the foreign context in India. Identifying the need for simplifying the registration process by transferring responsibilities to Designated Depositary Participants (DDPs), SEBI introduced SEBI (Foreign Venture Capital Investors) (Amendment) Regulations, 2024.
Key Amendments
1. Onboarding of DDPs and Registration Process
The Amendment Regulations have revamped the FVCI Registration process and application for grant of certificate. Previously, applications were submitted directly to SEBI. Now, applicants must apply through a Designated Depository Participant (DDP), submitting a completed form and a USD 2,500 fee (excluding GST). DDPs are authorized to issue registration certificates on SEBI’s behalf after reviewing applications and verifying compliance. Notably, existing FVCIs are required to onboard a DDP, aligning with the new regulatory framework. This change decentralizes the process and enhances oversight of FVCI operations.
2. Conditions to Grant Licence
The Amendment Regulations maintain core FVCI requirements while introducing new obligations.[7] FVCIs must still adhere to the SEBI Act, appoint a domestic custodian, and maintain special bank accounts. However, they now must promptly inform SEBI and their DDP if they fail to meet eligibility criteria, within seven working days. DDPs are now responsible for verifying FVCIs’ ongoing compliance with eligibility standards.[8] These changes aim to enhance regulatory oversight and ensure FVCIs maintain their qualifications throughout their operational period.
3. Eligibility Criteria
The Amendment Regulations have significantly revised FVCI eligibility criteria, aligning them with those applicable to Foreign Portfolio Investors (FPIs).[9] Key changes include:
- Residency requirements now mandate applicants to be from countries with regulatory authorities signatory to specific international agreements, with exceptions for government-related investors.
- For banks, eligibility is tied to residency in countries with central banks that are Bank for International Settlements members, with certain exceptions.
- Stringent restrictions on beneficial ownership have been introduced. Persons on the United Nations Security Council’s Sanctions List are prohibited from being applicants or beneficial owners. Additionally, applicants cannot be residents of countries identified by the Financial Action Task Force as having strategic deficiencies in Anti-Money Laundering or Combating the Financing of Terrorism measures.
4. Renewal of Registration / Surrender of Certificate
The Amendment Regulations introduce significant changes to FVCI registration renewal and surrender processes.[10] FVCIs must now pay a $100 renewal fee (excluding GST) for each five-year block. Late fees are introduced for missed deadlines, similar to FPI regulations. If an FVCI without Indian investments fails to pay both renewal and late fees by the due date, it’s considered a voluntary surrender. For FVCIs with Indian investments, failure to pay within 30 days of the block’s expiry may result in registration suspension or cancellation.
5. Change in Registration Form
The FVCI registration process has been streamlined to align with the FPI framework. The new application form for FVCIs now resembles the Common Application Form (CAF) used for FPI registration. This updated form captures essential information including the applicant’s name, incorporation details, KYC information, and beneficial owner particulars.
6. Beneficial Ownership
The Amendment Regulations now require both existing and new FVCI applicants to disclose beneficial owner (BO) details to their Designated Depository Participants (DDPs). New applicants must provide BO information in their application form and annexure, as identified under the Prevention of Money-Laundering Rules[11]. BO details are considered material information for FVCIs. Consequently, FVCIs must inform SEBI and their DDP of any significant changes, including direct or indirect alterations to their structure, ownership, or control that differ from previously submitted information.
Analysis
The New SEBI Amendment Regulations represent a major change of direction in the linkage between FVCI register and Foreign Portfolio Investment frameworks toward greater efficiency and standardization. These changes included shifting the registration obligations to the DDPs new due diligence, compliance, and fee management procedures, new and adjusted fee scales, changes in eligibility criteria, and improvement of duties for FVCIs, as well as duties for the DDPs. These changes also correspond with SEBI’s overall approach of gradually departing from daily involvement in the work of various intermediaries while at the same time strengthening its policymaking and supervisory roles.
The integration of DDPs for registration is also expected to be seamless because FVCIs operate with domestic custodians for investment management and SEBI reporting. Additionally, it will ensure faster turnaround given the fact that DDPs have an existing mechanism that carries out the process of granting registration and post registration approvals of FPIs. This should reduce extra pressures on FVCIs. The amendments also seek to make the entire process much more specific, precise and clear which is reflected from their decision of consolidating the application form for grant of registration with the information sought in CAF into one.
One that stands out is the provisions touching the identification and verification of the BOs of FVCIs. This comes closely on the heels of SEBI’s efforts to unveil the BOs behind investment vehicles that are at work in India in addition to increasing transparency. Furthermore, the amendments to the eligibility criteria are also designed to reflect the best industry practices, and aligned with the laws in place such as Prevention of Money Laundering Act, 2002. It will ensure that funds are sourced from credible bona fide investors and remove any chance of ambiguity in the process. Furthermore, the amendment concerning the renewal of registration which has twofold benefits of preventing misuse of registration and reducing regulatory costs towards inactive FVCIs.
Combined, these regulations are set to enhance the practices of regulation, clarity, integration and systematic registration for the foreign investments in the country.
Conclusion
Over the past few years, the phenomenon of startups has developed rapidly in India and has established itself as a major player on the international market in the IT, biotechnology, healthcare, and education industries. Many of these are complemented by innovation sources, highly skilled talent, and technologies that have continued to gain momentum. However, entrepreneurship only fosters where aspiring young entrepreneurs get the right policy backing and access to capital. Recent changes made to FVC primarily sought to strengthen the FVC framework to better address the funding gap that separates the capital requirements of venture capital-backed start-ups from the funding that can be provided by conventional institutional lenders. Besides promoting direct financial needs of startups, these amendments are also beneficial for FVC investments to make India competitive in the long term for the global economy. In conclusion, the definitive need of the hour is the flourishing FVC ecosystem that can enable first generation entrepreneurs to unlock and unleash their creativity for their enterprises’ growth and, therefore, create jobs and help India retain its pole position in the global startup map.
Notes:-
[1] Securities and Exchange Board of India (Foreign Venture Capital Investors) (Amendment) Regulations, 2024 (India).
[2] Consultation paper on streamlining regulatory framework for registration of Foreign Venture Capital Investors (FVCIs), https://www.sebi.gov.in/reports-and-statistics/reports/may-2023/consultation-paper-on-streamlining-regulatory-framework-for-registration-of-foreign-venture-capital-investors-fvcis-_71391.html (last visited Sept. 25, 2024).
[3] Securities and Exchange Board of India (Foreign Venture Capital Investor) Regulations, 2000 (India).
[4] Foreign Exchange Management Act, 1999, (Act No. 42 of 1999) (India).
[5] Securities and Exchange Board of India (Venture Capital Funds) Regulations, 1996 (India).
[6] Securities And Exchange Board of India (Foreign Venture Capital Investors) Regulations, 2000 (India).
[7] Securities and Exchange Board of India (Foreign Venture Capital Investors) (Amendment) Regulations, 2024, Regulation 3 (India).
[8] Securities and Exchange Board of India (Foreign Venture Capital Investors) (Amendment) Regulations, 2024, Regulation 5 (India).
[9] Securities and Exchange Board of India (Foreign Venture Capital Investors) (Amendment) Regulations, 2024, Regulation 4 (India).
[10] Securities and Exchange Board of India (Foreign Venture Capital Investors) (Amendment) Regulations, 2024, Regulation 9 (India).
[11] The Prevention of Money-Laundering (Maintenance Of Records) Rules, 2005, Notification No. 444(E) (India)./ The Prevention of Money Laundering (Maintenance of Records) Amendment Rules, 2023 (India).
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The article is a co-authored piece, by authors- Sahil Singh (2nd-year law student at CNLU Patna), and Anuja Chatterjee (2nd-year law student at CNLU Patna)
