SEBI FPI Regulation Issue

Context:

  • On 10th April 2018, the market watchdog, SEBI asked category II and III FPIs (not well-regulated in their countries of origin) to conform to a higher degree of KYC norms in order to curb round tripping of illicit money and strengthen anti-money laundering measures.
  • It asked category II and III FPIs to provide the list of their beneficial owners (BO) along with their identification and verification in a certain format within six months.
  • The measures were mainly targeted towards “high-risk” nations with a history of money-laundering, terrorism and so on.
  • On Sept 10th 2018, lobby group Asset Management Roundtable of India or AMRI said that the immediate impact of the new SEBI norms, if not amended, will be that $75 billion worth foreign portfolio investment managed by overseas citizens of India (OCIs), persons of Indian origin (PIOs) and non-resident Indians (NRIs) will be disqualified from investing in India, and the funds will have to be withdrawn and liquidated within a short time frame.
  • This created quite a scare in the capital market, especially at a time when the rupee is in freefall and struggling under external pressure and has raised questions about SEBI’s handling of the issue and the need for wide consultation before drafting such regulations.

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Who are Foreign Portfolio Investors?

  • In India, the term “Foreign Portfolio Investor” refers to FIIs. FPI stands for those investors who hold a short term view on the company, in contrast to Foreign Direct Investors (FDI). FPIs generally participate through the stock markets and gets in and out of a particular stock at much faster frequencies.
  • Foreign portfolio investment differs from foreign direct investment. In foreign portfolio investment the investor purchases stocks, securities and other financial assets but does not actively manage the investments or the companies that are issuing the assets. So, in FPI the investor does not have direct control over the securities or businesses.
  • This means that FPI tends to be more liquid. The relatively high liquidity of FPI’s makes them much easier to sell than FDI’s. Hence FPI investments are considered volatile compared to FDI and is termed as ‘Hot Money’.
  • FPI route is also preferred by those who are seeking to launder black money and hence SEBI closely regulates the flow of FPIs.
  • Portfolio Investment by any single investor or investor group cannot exceed 10% of the equity of an Indian company, beyond which it will now be treated as FDI.

 

Concerns of SEBI

  • SEBI’s April 10th rules were framed in line with anti-money laundering norms and the Prevention of Money Laundering Act.
  • FPIs have invested in securities worth at least $450 billion in Indian equities. Of this, NRIs have invested around $75 billion through India-focused funds in which majority owners are FPIs.
  • So there is an urgent to monitor and regulate the flows to prevent round tripping of illicit money.
  • SEBI had said that FPIs should provide information of the real owners or effective controllers of those companies and trusts.
  • SEBI had said that if the beneficial owner (BO) exercises control through means like voting rights, agreements and arrangement then that should also be specified.
  • Such BOs, it added, should not be from jurisdictions that are combating financing of terrorism deficiencies to which counter measures apply or those that have not made sufficient progress in addressing these deficiencies.
  • SEBI had setup a committee under the chairmanship of former deputy governor of RBI, H.R. Khan to review the FPI rules. The panel will also look into the issues raised with regard to the April 10th circular. 

 

Concerns of FPIs:

  • The Asset Managers Roundtable of India (AMRI) warned that India’s booming stock markets will be in for a tight bear-hug and the embattled rupee could face even greater pressure if the April 10th diktat of SEBI is not scrapped.
  • AMRI argued that the SEBI circular disqualifies about $75 billion of portfolio investments into India made by FPIs backed by domestic institutions, NRIs, Persons of Indian Origin and Overseas Citizen of India card-holders.
  • The H.R. Khan Committee set up by SEBI has recommended changes that may be made to the regulator’s directive, addressing most of the concerns raised by the FPIs.
  • The panel’s report clarified that NRIs, OCI card-holders and resident Indians can manage the investments of any FPI registered with SEBI and, more importantly, hold up to 50% of an FPI’s assets under management.
  • This has removed any ambiguity and provided relief to foreign investors who were left guessing how the term ‘majority’ — as stated in the April circular — would be determined by SEBI while applying the beneficial ownership test.
  • The committee also said the deadline for complying with the circular, which was already extended from August 31 to December 31, must be extended further, and funds with investments breaching the final thresholds that the regulator decides upon should be granted 180 days to unwind positions.
  • FPIs have appealed to the PM to have a relook at the SEBI circular and have asked SEBI to have a process of consultation before notifying such rules.

 

Way Forward:

  • SEBI has now announced public consultations before it finalises these norms, and in the process created some breathing space for FPIs to remain invested.
  • There should be no issues with attempts to curb round-tripping of illegal domestic wealth into the Indian market through the foreign investments route.
  • But treating all FPIs with Indian-origin managers as potential suspects and conduits of money laundering is unwise.
  • SEBI could have managed all of this as an independent regulator had it held public consultations and timely dialogue with stakeholders before framing these norms.
  • Such uncertainty in policy and frequent U-turns will do little to enhance India’s credibility among global investors and FPI being a part of India’s capital account and balance of payments, it plays a crucial role in balancing the deficit and hence SEBI needs to adopt a more consultative approach.