Indian private equity funds in the infrastructure sector are hobbled by an ?unfriendly? regulatory regime, with their big-ticket FDI proposals hitting a policy hurdle. The finance ministry has put on hold two proposals by India-registered infrastructure trusts to tie up a total of $2.5 billion in foreign direct investment (FDI), owing to the difficulty in defining the ownership of these trusts.

Under the FDI policy, ownership of an entity is counted before deciding if it can accept FDI. Since trusts have only beneficiaries, rather than owners, it is hard to determine who owns a venture capital trust, especially if it has non-resident ?beneficiaries.?

The Foreign Investment Promotion Board (FIPB) deferred decisions on two FDI proposals from trusts at its last meeting on December 18, sources said. While a trust fund, promoted by Macquarie and State Bank of India (SBI), proposed to bring in $2-billion FDI, another trust, promoted by UTI AMC, HSH Nordbank and Noor Financial, with a target size of $500 million approached the FIPB. Both trusts are private equity funds formed to invest in India?s infrastructure sector.

Even though the department of industrial policy and promotion (DIPP), which defines the FDI policy, supported the proposals, the finance ministry representatives in the Board wanted to put them on hold fearing that FDI into these trusts could amount to circumvention of new FDI guidelines under Press Note 2, 3 and 4.

DIPP has supported the proposals subject to a condition that these funds cannot invest in sectors that have entry restriction and investment caps. These sectors include retail, real estate, telecom and banking among others.

In the past, many such cases involving FDI in trusts have been rejected or held up for long by the Board based on the premise that investments in these funds, which are registered as venture capital funds in India issue units to the foreign investors instead of shares. The FDI policy?which permits issue of shares by an Indian companies to foreign companies?is silent on the issue on FDI in trusts wherein the trust that is registered as VC issues units in lieu of cash.

Since most venture funds are set up as trusts under the Indian Trusts Act 1882, wherein ownership and control are not defined unlike in the Companies Act 1956, it is unclear whether the government will treat their investments as FDI. Venture funds can be set up as trusts and companies. About 99% of the venture funds are floated as trusts to save on dividend distribution taxes, which have to be paid by a company.

Complications arise since trusts have only beneficiaries, and not owners, which makes it hard to say who owns a venture capital trust, especially if it has non-resident beneficiaries.

While Macquarie-State Bank of India (MSIF) will continue to raise capital during 2009, and together with Indian domestic institutions, the total capital is anticipated to be up to between US$2 billion, according to the proposal with the FIPB.

Foreign institutions will invest through MSIF and Indian domestic institutions will invest through a domestic entity called the SBI-Macquarie Infrastructure Trust (SMIT). MSIF and SMIT will invest together into infrastructure projects in India.

MSIF is managed by the SBI and Macquarie joint venture, with the International Finance Corporation (IFC), , as a minority shareholder and cornerstone investor in MSIF. SMIT will also be managed by the joint venture.

The second trust is of the Unit Trust of India Asset Management Company (UTI AMC), Germany?s HSH Nordbank and Kuwait?s Noor Financial Investment Company with the aim to invest $500 million in India. As per their proposal with the FIPB, the fund?smandate is to invest in unlisted companies involved in the infrastructure industry in India.

The India Infrastructure Development Fund will make investments in unlisted companies engaged in transport and energy and utilities in India. The fund is already in existence, albeit in a limited form, under the management of UTI AMC, and has already made an investment in Sabarmati Gas, a gas distribution project in the state of Gujarat.

According to Finance Asia, the funds will mainly be sourced internationally, though local investors will also have a presence. Through their participation in the fund, both Nordbank and Noor will increase their exposure to India?s infrastructure sector. Nordbank is already involved in the financing arrangements of the New Delhi airport modernisation project.