SEBI Lens on FPIs Under NRI ‘Control’

SEBI Lens on FPIs Under NRI ‘Control’

Eye on 2019 Polls: Custodians of FPIs told to identify such offshore funds

The Securities and Exchange Board of India has asked custodians of foreign portfolio investors (FPIs) to identify offshore funds that are ‘controlled’ by nonresident Indians.

Sebi, acting on the government’s instructions, has made it clear through fresh restrictions on investments and in subsequent meetings over the past few weeks that it’s not in favour of NRIs using FPI vehicles to trade on Indian stock exchanges.

This is primarily due to a growing suspicion that resident Indians have been using NRI friends and relatives to bring back and legitimise undisclosed funds parked abroad through fund structures that are registered as FPIs with the capital markets regulator. It is widely perceived that New Delhi is trying to minimise the inflow of money through round-tripping in the run-up to the 2019 elections.

“Many custodians were told last week to share data. It is evident Sebi is serious about the regulation and will retain it in some form. While Sebi probably wants to assess the total size of NRI-linked funds, compiling information on thousands of funds — on who controls a structure and how — cannot be done overnight,” a person aware of the development told ET.

Information on ‘Control’ Never Collected in Past

Custodians — which are large multinational banks and arms of Indian financial services groups handling the investments of foreign institutional investors — have to spell out the way NRIs exercise control in various FPI entities; whether they have the power to appoint majority of the directors and enjoy majority of the voting rights.

Custodians, who carry out knowyour-customer (KYC) formalities for foreign funds investing in India, however, have never in the past collected information on ‘control’.Around mid-April, Sebi came out with a new rule that said NRIs cannot be ‘beneficial owners’ (BO) of FPIs. According to the regulator’s definition, BO would mean 25% ownership in a company or 15% in a trust or partnership — depending on how an FPI is structured abroad. Second, the BO rule would also be triggered if the fund’s senior management officials are NRIs even though such persons may not have any investment in the fund.

Third, the threshold (for establishing NRI control or dominance in the fund pool) would be at a lower (and thus more stringent) level of 10% if the FPI is based in a high-risk jurisdiction. (Custodians and regulators have not yet come to an agreement on countries that would be considered ‘high risk’.) The regulation shook many NRI fund or asset managers who have set up offshore structures for raising funds from foreign residents as well as persons of Indian origin.

“The structure of several funds managed by Indian groups, NRIs, PIOs (Persons of Indian Origin) and OCIs (Overseas Citizens of India) could face a challenge due to the Sebi restriction on such persons being beneficial owners through control or a senior management official. Such funds might either have to change their operating structures or Sebi would have to dilute the requirements if these funds have to continue investing in India,” said Rajesh Gandhi, partner at Deloitte India.

“Faced with the Sebi directive, funds and their advisers are now discussing possible structures to sidestep the Sebi circular — for instance, either by ostensibly transferring control to foreigners or through setting up trusts,” said a senior tax practitioner.There are 9,500 FPIs and it could take custodians weeks to collect information on who controls a fund.

For new funds, custodians are already gathering such information. “Sebi has received many representations from FPIs, custodians and some of the intermediaries. It may review the definition of ‘control’, but is unlikely to make any significant relaxation in the rules,” said an official of a custodian bank.

The Economic Times, New Delhi, 04th June 2018