he Securities and Exchange Board of India (SEBI) in December 2012 had set up a committee to suggest measures for rationalisation of foreign portfolio investments in India.
The foreign portfolio investments consist of investments in Indian listed securities by foreign institutional investors (FIIs), Sub-Accounts of such FIIs, Non-Resident Indians (NRIs) and Qualified Foreign Investors (QFIs).
The committee, under the chairmanship of former Cabinet Secretary K. M Chandrasekhar submitted its report to SEBI on June 12, which endorsed the 2013 budget proposals for uniform registration and other liberalised investment norms for foreign portfolio investors. SEBI, in its recent meeting on June 25, has accepted the committee’s recommendations, which are likely to be implemented soon.
The key recommendations, which have been accepted by SEBI, are summarised as follows:
First, uniform entry norms for foreign investors such as FIIs, Sub Accounts and QFIs (excluding NRIs), by merging them into a new investor class termed as ‘Foreign Portfolio Investors’ (FPIs).
Second doing away with prior SEBI registration for FII/Sub-Accounts and instead register them as FPI with a SEBI authorised Designated Depository Participant (DDP).
Third, a risk-based approach to be adopted while conducting know your client (KYC) and registering the FPIs with DDPs.
To achieve this, the FPIs would be divided in to three categories.
Category I will consist of Government entities such as sovereign wealth funds, foreign central banks. Category II will consist of regulated entities such as banks, investment managers, broad-based funds etc and Category III would be the residual category. The KYC norms for Category I would be simplest and most stringent for Category III.
Proposals look promising
Fourth, foreign portfolio investments would mean investments by any investor or investor group up to 10 per cent of the equity of an Indian company.
Investments beyond 10 per cent would be considered as Foreign Direct Investment (FDI).
The proposals (on the face of it) look promising for foreign investors and Indian markets. However, on a finer analysis one would find certain issues and concerns which may arise while implementing the recommendations.
Some of them are discussed below:
First, doing away with SEBI registration for FII/Sub-Accounts and mandating them to be registered with DDPs is essentially a delegation without significantly diluting the registration requirements.
To draw inference, rigorous processes are applicable on QFIs for opening account with qualified depository participants (QDPs). QDPs are also entrusted with the responsibility to follow the applicable domestic laws of the QFIs.
Such similar norms would be applicable on DDPs and in fact additional qualifications to register as a DDP (compared to QDP registration) with SEBI have been proposed. For instance, a DDP is proposed to have a custodian licence, should be an authorised dealer Category I bank, have a multinational presence etc.
Such rigorous requirements were not prescribed for QDPs under QFI regime, as a result of which many of the existing QDPs would not qualify as a DDP.
A one year grace period for QDPs to qualify as DDPs has been recommended, but may not be sufficient.
Second, it needs to be seen that how the transition happens for already registered FIIs, Sub-Accounts and QFIs. Will they continue to be governed by the old norms or new procedures would be prescribed for them to migrate, needs to be seen. Amendments (and where applicable, repeals) would be required in SEBI laws, Foreign Exchange Management laws, FDI regime and it will be a tedious process.
Third, an investment limit of 10 per cent of paid-up equity capital of an Indian company has been prescribed per FPI entity.
Ownership of more than 50 per cent in two or more FPIs for common beneficial owners will result in shareholding of such FPIs to be clubbed in order to compute the 10 per cent investment limit. 50 per cent seems to be on the higher side as the same may allow the offshore investors to structure their investments in a manner which may indirectly and in spirit violate the sanctity of the 10 per cent investment limit.
SEBI and RBI may need to consider some alternative computation methodology in this regard.
Fourth, it is proposed that FPIs under Category I and II can issue participatory-notes. The Category II also consists of broad-based funds. Many such funds typically register as sub-accounts under the SEBI FII regime.
Sub-Accounts were prohibited by SEBI from issuing P-Notes in 2007. SEBI therefore needs to be more careful while framing the final policy in this regard.
The devil lies in the details and one needs to see how the proposals are implemented. As multiple regulators will have to put their acts together, any turf wars should be avoided. The success of the new regime would also depend on DDPs who will have to balance their regulatory and commercial goals.
Relaxing the entry requirements to an extent of facilitating round tripping and inflow of black money is not desirable and the new norms should ensure that quality and source of inflows is clean and intact.
India’s sound internal policies safeguarded its economy from the tremors of global slowdown which saw several world economies and giants fail. One would expect that good work to continue.
The author is Partner,
IC Legal (Advocates & Solicitors), Mumbai
The devil lies in
the details and one needs to see
how the proposals
regulators will have to put their acts together,
any turf wars should be avoided.