Explained: New Rules for Foreign Portfolio Investors – SEBI’s Move to Slice through Corporate Layers

16 Oct 2023
  • DMD Advocates
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The Securities & Exchange Board of India (SEBI) recently issued a circular amending the Foreign Portfolio Investors (FPI) Rules, in terms of additional granular disclosures to lift the veil off the Ultimate Beneficial Owners (UBO). The entities have only 90 days to comply with the mandates, which will be closing around November 2023. It is pertinent to understand the stipulations, the regulator’s intent, and the significance for stakeholders to abide by the new directives.

The tweaks come in light of the regulator’s attempts to trace the real identities of the ultimate beneficiaries of a handful of FPIs invested in Adani Group Companies. The Adani group incident has underscored the glaring possibility of one natural person holding a significant economic interest in FPI via various investment vehicles.

The concentration of investments by FPIs in a single group or company acting in concert with the promoters of corporate groups breaches the Minimum Public Shareholding (MPS) regulatory requirement of 25 percent in the listed entity. This impacts the price volatility while the ultimate beneficiary hides behind corporate cloaks.

The circular aims to address such situations where stakeholders are unaware of other participants who have sway over the share prices, management dynamics, and corporate decisions.

What is the SEBI directive?

The circular targets the FPIs based in ‘High-Risk jurisdictions’ that pose a higher risk of money laundering or terror financing. SEBI estimates that high-risk FPIs that hold over a fund size ceiling of Rs 2.5 lakh crore worth of assets under management would need to make these additional disclosures.

Such FPIs are required to undergo enhanced scrutiny and stricter KYC norms. They are mandated to make annual disclosures of their ultimate beneficiaries, submit monthly consolidated reports of investments across securities and report changes in shareholding exceeding 10 percent within 15 days. This shifts the onus on the listed entities and the FPIs to maintain adequate records and notify the authorities in line with the continuous disclosure regime adopted by SEBI.

It has also mandated granular reporting of data by entities with any ownership, economic interest, or control rights in high-risk FPIs. This means that even a percentage of direct or indirect holding in high-risk FPIs will be required to be reported. This will be compulsory irrespective of overseas jurisdictional laws for the secrecy/confidentiality of its domiciled investors.

This will solve two-fold concerns of the regulator in monitoring the high-risk FPIs in a manner that ensures that investors are not pushing back the overseas funds belonging to the promoters, and they are not routing money from surreptitious entities sharing borders with the Indian subcontinent.

The move shall ensure that the promoters are not breaching the MPS ceiling and that 25 percent shares of the listed entity are actually available for trading on the public bourses.

In order to meet this compliance, the FPIs will either have to embrace the regulator’s directive, or divest to bypass scrutiny, or diversify their holdings. It is pertinent to note that the circular stipulates exemptions from granular disclosures for certain FPIs that have a broad-based, pooled structure with a wide investment base. These include government or government-related investors, public retail funds, Exchange Traded Funds with less than 50 percent exposure to Indian markets, pooled investment vehicles, and such FPIs that are unable to liquidate.

Right off the bat, this is a move to uncloak the ultimate beneficiaries of the funds.

Earlier attempts and the final call to unveil real beneficiaries

This circular is a severe departure from the earlier stances held by the regulator.

The SEBI (FPI) Regulations, 2014 did not require an upfront declaration of all the last natural persons for registration of FPIs. The requirement to disclose was triggered for only such entities holding a stake over 25 percent in the said FPI, as per the Prevention of Money Laundering (PML) (Maintenance of Records) Rules, 2005. The threshold was reduced to 10 percent earlier this year.

Moreover, the Listing Obligations & Disclosure Requirements (LODR) obligated the listed entity to comply with the MPS requirement and disclose significant beneficiaries in the shareholding pattern. The Ministry of Corporate Affairs too had issued stringent disclosure obligations on individuals holding a certain percentage of beneficial interest in Indian companies under the Companies (Significant Beneficial Owners) Rules, 2018. However, this was limited to Indian companies alone.

The beneficiary regulations were further tightened when upfront disclosure of FPI BOs was mandated in 2018 and the reference to opaque structures of FPIs were deleted in 2019 to end ambiguity. Until then, the opaque structure doctrine protected FPIs from disclosing the ultimate natural person at the end of the chain.

Additionally, the Indian Government put out protectionist measures to curb opportunistic takeovers in the wake of Indo–Chinese tensions, in 2020. This was known as the ‘Press Note – 3’. It spelt out rules for ultimate beneficial owners of investor entities originating from neighbouring countries sharing borders with India.

The earlier directives aimed to pierce the corporate veil and identify the UBOs of the FPIs. However, they failed as it counteracted the government’s initiatives for ease of doing business. Furthermore, the rules were inadequate for the determination of ultimate beneficiaries of the FPIs and whether the overseas funds were to comply with these guidelines. The FPIs and their investment vehicles were not regulated enough due to each being below the statutory threshold under the PMLA 2005 rules.

Thus, the circular

This is SEBI’s third attempt and final call for objectivity, after the directive to provide details of senior management of the ultimate parent entity of all existing FPIs who had declared no UBO from ownership or control perspectives.

These changes aim to strengthen due diligence norms in Indian securities markets, promote proactive reporting, and mitigate international financial crimes. This will also lead to the diversification of FPI portfolios by potentially increasing the return on investments and decreasing their risk exposure.

In addition to getting rid of the menace of promoters masking their shareholding in listed companies, this may be deemed progress in ensuring free float of shares and better price discovery in the Indian market.

The circular holds a significant impact considering the ongoing probe into the Adani incident. The allegations levelled against the Adani group underscore the loopholes under the previous disclosure regime that may have been exploited by ultimate beneficiaries of the FPIs invested in the group. The roll-out of the additional granular disclosures of FPI BOs strikes at the heart of this issue.

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