Mumbai: Promoter families and unwanted foreign investors cannot hide behind overseas insurance firms and cells and sub-funds of offshore pooled vehicles which step in as foreign portfolio investors (FPIs) to surreptitiously own shares and manipulate stocks of companies listed in India.
A standard operating procedure (SOP) finalised by custodians of FPIs and the Securities and Exchange Board of India (Sebi) over the weekend has laid down the ground rules to stop the misuse of such overseas investment entities, two persons familiar with the subject told ET.
The SOP comes in the wake of the new disclosure regulations that would compel any FPI breaching certain investment limits to reveal the identities of every individual behind the entities which have put money in the fund or have control over it. The rigorous disclosure rules will be triggered on an FPI whose exposure to equities in India crosses ₹25,000 crore, or which has invested 50% of its India assets under management in stocks of companies belonging to a single corporate group.
The regulations, which will come into effect from November 1, are a fallout of the fiasco caused by the American short-seller Hindenburg which alleged the Adani group of price manipulation and accounting fraud.
However, certain FPI entities – depending on their ownership, constitution and purposes – are exempted from the disclosure regulations as long as they fulfil and demonstrate some criteria. Overseas insurance (and reinsurance) entities and pooled investment vehicles, besides pension funds and exchange-traded funds, are in the exempted category, albeit under certain conditions.
Unlike insurers in India, overseas insurance companies offer products where the investor has a say in how the money is deployed. Under such an arrangement, the investor calling the shots masks its identity behind the insurance company which registers as an FPI with Sebi. Similarly, pooled vehicles like a protected cell structure (PCC) in Mauritius or a Singapore-based variable capital company (VCC) with multiple sub-funds can house a few or a single investor who indirectly controls it.
ONEROUS TASK
Against this backdrop, the SOP spells out that foreign insurers and pooled vehicles, coming in as FPIs, will be spared from disclosing all their beneficial owners (when investment limits are breached) only if they can establish that “the FPI is not maintaining segregated portfolio with one-to-one correlation with a single investor”. A PCC (with different cells or schemes like a mutual fund ) or VCC (in the form of an umbrella fund with multiple sub-funds) seeking exemption from the total ownership disclosures, have to ensure that “a common portfolio is maintained across investors” at each cell and each sub-fund.
If it is found that an insurer or a pooled vehicle is controlled by an investor such an FPI will have to disclose the identities of all the natural persons behind the structure when investment limits are breached.
“The issuance of the SOP would help ensure consistent practice and removal of regulatory arbitrage amongst DDPs (designated depository participants or custodians) who facilitate transactions of FPIs. However, I see two outcomes of this entire process of seeking stricter and granular disclosures. Firstly, it will likely result in an increased burden on DDPs in terms of verification of information, reporting, and document collection. Secondly, while in reality the enhanced disclosure norms are expected to impact only a small number of high-risk FPIs, as India continues to attract increased foreign capital, it will also need to deal with the perception of having onerous market entry norms, relative to some other jurisdictions,” said Tejas Desai, partner, private equity and financial services (tax and regulatory services), at EY.
Custodians not only have to cross-check whether exempted FPIs have a common pool and are not controlled by a single investor, but they must obtain certified or attested documents issued by a regulator stating that an FPI is in the nature of a regulated insurance scheme, or a pension fund. The SOP is categorical that custodians will have to obtain these documents and cannot rely only on the declarations of FPIs.
Sebi had originally issued a consultation paper seeking additional disclosures from FPIs that had either taken concentrated exposures to a single corporate group or had outsized India allocation. In such cases, Sebi sought to obtain granular data of ownership, economic interest, or control in the FPI, on a look-through basis, up to the level of all natural persons.
“The issuance of the Circular in August and Operating Procedures now, have largely been directed to fine-tune the risk-based segmentation of FPIs to limit the look-through approach on disclosure for FPIs that don’t pose systemic risks (government-related funds, retail funds, and regulated funds operating within reasonable investment allocation thresholds) or face constraints in adhering to the specified limits (funds that are in wind-down mode or are yet to meaningfully commence investment activities). To that extent, the Circular and the operating procedures seem well calibrated to achieve the objectives that were initially identified in the consultation paper,” said Richie Sancheti, founder of the law firm Richie Sancheti Associates.
Existing FPIs that are in breach of the investment limit as of October 31, 2023, will have to bring down such exposure within 90 days – or, by January 29, 2024. If it cannot, the FPI must disclose the identities of all its beneficial owners by March 11, 2024, failing which it was to fold up. FPIs that breach the investment limit post-November 1, will have to pare their exposures in 10 days.
