[Palash Varyani is a 3rd-year B.A., LL.B. (Hons.) student at the Institute of Law, Nirma University, Ahmedabad]
In a recent development, the Securities and Exchange Board of India (SEBI) has mandated foreign portfolio investors (FPIs) who meet the stipulated criteria to demonstrate an unprecedented level of transparency regarding their beneficial ownership structures. This disclosure requires FPIs to disclose all entities that wield any form of ownership or economic influence, as well as those exercising control, in a “full look through” manner, extending scrutiny to encompass every natural person involved, without regard to predefined thresholds.
This has far-reaching implications for both the financial industry and regulatory authorities alike. This article delves into the intricacies of this SEBI circular, decoding the underlying rationale, exploring the loopholes and its potential implications for participants in the Indian securities market.
Decoding the Rationale behind the SEBI Circular
This measure is motivated by SEBI’s concerns regarding the potential misuse of the FPI channel by specific FPIs. SEBI has observed instances where Indian entity promoters indirectly maintain significant ownership stakes in their own companies through FPIs. In such cases, a substantial portion of the FPI’s investment portfolio is concentrated in a single investee company or corporate group. This set up allows the promoters and Indian investors to potentially evade the disclosure requirements specified in the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011, as well as the obligation to maintain a minimum level of public shareholding in the listed entity.
SEBI has also recognized the possibility of a single individual holding a substantial combined economic interest in an FPI through multiple investment entities, each falling below the threshold defined in the Prevention of Money Laundering (Maintenance of Records) Rules, 2005 for identifying beneficial owners.
In response to these concerns SEBI has issued the FPI circular. This Circular requires FPIs that meet the specified criteria to make additional disclosures as regards beneficial ownership to their Designated Depository Participants (DDP).
Analysing the Circular
SEBI’s circular introduces two primary criteria that trigger mandatory disclosures for FPIs: First, FPIs that hold more than 50% of their assets under management (AUM) in the equity of a single Indian corporate group. Secondly, FPIs that possess equity AUM in the Indian markets exceeding INR 25,000 crore, either individually or as part of an investor group. These criteria seem reasonable as they target FPIs with significant exposure to Indian corporate groups or large investments in the Indian market. It promotes transparency by identifying FPIs with concentrated positions, which can have implications for market stability. Several categories of FPIs have been exempted from this requirement. For instance, FPIs whose holding in an Indian corporate group is below 25% of their overall global AUM at a scheme level, FPIs whose equity AUM in the Indian markets is below 50% of their overall global AUM at a scheme level, FPIs who are unable to liquidate their excess holdings due to statutory restrictions (such as lock in restrictions generally applied to anchor investors), and so on. In these cases, the FPI claiming an exemption will require to satisfy its DDP about its eligibility for the exemption, further increasing the compliance burden of investing in Indian securities markets.
Furthermore, the constituents of FPI investor group which collectively hold more than INR 25,000 crore of equity AUM in the Indian markets shall be exempted from making the additional disclosures if the investor group consists of FPIs that qualify for exemption. This group exemption approach encourages cooperation among FPIs within a group and aligns with the aim of transparency. However, it may introduce complexities in tracking compliance, and ensuring accurate calculations will be crucial.
The “look-through” approach provided in the circular, requires entities holding ownership interests in FPIs to disclose their ownership structures. This approach is essential to prevent FPIs from circumventing the disclosure requirements through complex ownership structures. It strengthens the regulatory framework by enhancing transparency and preventing regulatory arbitrage.
The SEBI’s circular introduces reasonable criteria for mandatory disclosures by FPIs, aimed at enhancing transparency and regulatory oversight. The exemptions, group exemptions, look-through approach, and other guidelines contribute to a well-structured framework. However, the effectiveness of these guidelines will depend on their implementation and monitoring.
Exploring the Lacunae of the Circular
SEBI’s recent guidelines on mandatory disclosures for FPIs aim to bolster transparency and regulatory oversight in the Indian market. However, several critical loopholes in these guidelines raise concerns about their effectiveness and fairness.
One glaring issue is the lack of clarity in defining a “single Indian corporate group” in the criteria that trigger mandatory disclosures. This ambiguity can lead to confusion and inconsistent interpretations. Additionally, the exemptions granted to certain FPI categories, such as government-related investors, raise questions about its transparency. Entities with close government ties could exploit these exemptions to bypass disclosure requirements, undermining the very transparency these guidelines seek to enhance.
Furthermore, the guidelines appear to have insufficiently considered the potential market impact. While regulatory oversight is vital, mandatory disclosures could lead to market volatility if large FPIs are compelled to rapidly reduce their holdings, affecting other market participants. Moreover, the absence of a consultation process with stakeholders regarding the formulation of standard operating procedures (SOPs) for compliance enforcement could result in impractical or burdensome procedures that fail to address industry-specific nuances.
The guidelines also impose a relatively short compliance timeline of 30 trading days once the thresholds are triggered. This timeline may pose operational challenges, especially for larger FPIs with complex portfolios, potentially forcing rushed decision-making. Furthermore, the additional compliance burden, the severe consequences of non-compliance, including registration cancellation, could discourage FPIs from investing in the Indian market, hampering capital inflows crucial for economic growth and market development.
Lastly, the guidelines fail to account for exceptional circumstances like unforeseen events or market crises that could make it challenging for FPIs to meet disclosure deadlines, and the guidelines do not provide flexibility for such contingencies. Although the guidelines are well-intentioned, it is imperative to rectify these significant loopholes to establish a regulatory framework for FPIs in the Indian market that is equitable, pragmatic, and efficient.
Implications of the Circular and Future Prospects
The introduction of SEBI’s circular establishing mandatory disclosure criteria for FPIs carries far-reaching implications for both the Indian financial markets and the FPIs navigating them.
One prominent implication is the advancement of transparency and regulatory oversight. These guidelines specifically target FPIs with concentrated investments, particularly those holding substantial equity stakes in individual Indian corporate groups. By doing so, SEBI aims to illuminate potential vulnerabilities and risks tied to these concentrated positions, which could ultimately bolster market integrity. These guidelines are also likely to influence FPI investment strategies significantly. FPIs, especially those with substantial AUM in the Indian markets, may need to recalibrate their investment approaches and portfolios to align with the new disclosure prerequisites. This could necessitate portfolio adjustments, asset reallocation, and possibly even a re-evaluation of investment preferences.
Operational challenges loom on the horizon for FPIs. The stringent compliance timelines, particularly the requirement for FPIs to adhere to the 50% equity AUM threshold within ten trading days, pose operational complexities. Larger FPIs with intricate portfolios may find it daunting to meet these tight deadlines, potentially necessitating substantial modifications to their operational procedures.
The recent SEBI circular seeks to address often voiced concerns regarding the potential misuse of the FPI channel and seeks to mitigate risks associated with concentrated investments. Clarity in definitions, flexibility in compliance timelines during exceptional circumstances, and regular stakeholder consultations should, however, be considered to make these additional compliance burdens both palatable and effective.
– Palash Varyani