SEBI Puts Brakes on Overseas ETF Investments by Mutual Funds

The Securities and Exchange Board of India (SEBI), the primary regulator of the Indian securities market, took a significant step on March 20, 2024 by directing the Association of Mutual Funds in India (AMFI) to curb fresh investments in overseas Exchange Traded Funds (ETFs) by mutual funds.

Overseas Investments and Limits

Mutual funds in India play a crucial role in channelling domestic savings towards productive investments. These investments can include domestic equities, debt instruments, and even overseas assets. The RBI, however, sets limitations on the total amount of money mutual funds can invest outside India. This overall limit currently stands at USD 7 billion.

Within this broader limit, SEBI has further established a separate ceiling of USD 1 billion specifically for investments in overseas ETFs. These ETFs are investment instruments listed on international exchanges that track a basket of underlying assets, such as stocks or bonds. By investing in overseas ETFs, mutual funds offer investors a convenient way to gain exposure to foreign markets and diversify their portfolios.

The Trigger: Nearing the Overseas ETF Limit

The recent directive from SEBI is a proactive measure to prevent a potential breach of the USD 1 billion limit for overseas ETF investments. Industry sources indicate a surge in investor interest in overseas ETFs, raising concerns about exceeding the prescribed limit in the near future. By halting fresh inflows, SEBI aims to ensure compliance with the regulatory framework and maintain a balanced approach to foreign investments.

There are, in fact, two different kinds of mutual fund schemes that make foreign exchange investments. One purchases overseas shares overseas, up to a USD 7 billion maximum. The other kind of fund which is a Fund of Funds scheme normally purchases ETF units overseas (up to a USD 1 billion maximum).

Fund houses accepting money in these Fund of Funds or ETFs that invest money in overseas ETFs will have to put a halt/stop to it. With effect from April 1, 2024, this directive attempts to uphold regulatory conformity with the Reserve Bank of India's (RBI) foreign investment limitations.

Depending on how near they are to reaching their upper limits when it comes to investing your money overseas, foreign mutual funds cease accepting money and resume accepting it. So far, the inflow of funds into these kinds of initiatives has been uneven.

Nippon India US Equity Opportunities, Nippon India Japan Equity, Nippon India Taiwan Equity, and Nippon India ETF Hang Seng BeES, the four Nippon India Mutual Fund funds, ceased accepting contributions on February 26. The Systematic Transfer Plans (STPs) and Systematic Investment Plans (SIPs) that are currently registered will remain in place; Nippon India Mutual Fund stated.

[Read: Is It Worthwhile Adding International Mutual Funds to an Investment Portfolio?]

While the immediate impact of SEBI's directive is clear, there are broader implications to consider:

• The decision might limit investor options for geographically diversified portfolios.

• This could prompt a re-evaluation of investment strategies and a renewed focus on domestic investment opportunities.

• The mutual fund industry could explore alternative structures for offering exposure to foreign markets, potentially through actively managed funds that invest directly in overseas stocks.

The future course of action will likely depend on various factors, including market conditions, investor behaviour, and the RBI's stance on overall foreign investment limits for mutual funds. SEBI is expected to monitor the situation closely and make further adjustments if necessary.