India: Revised Norms For FPIs: New Wine In A New Bottle

The norms surrounding foreign portfolio investors have undergone continuous changes and tweaks since liberalisation. The framework introduced by Central Government was first consolidated and expanded upon by the Securities and Exchange Board of India (SEBI) under the SEBI (Foreign Institutional Investors) Regulations, 1995 (1995 Regulations).

A little under a decade later, in 2014, SEBI took steps to consolidate the categories of investors previously accessing Indian capital markets – i.e., foreign institutional investors, sub-accounts and qualified foreign investors – into a single class known as 'foreign portfolio investors' (FPIs). SEBI also delegated the responsibility of registering such FPIs to designated depository participants (DDPs). Multiple questions arising out of the new regime were subsequently answered by SEBI in a series of frequently asked questions (FAQs), updated from time to time. The 2014 Regulations also incorporated concepts such as opaque structures and a scope of investor group, which did not find a mention in the 1995 Regulations but were introduced through notifications and instructions from SEBI.

Five years later, SEBI has issued revised norms for FPIs in terms of the SEBI (Foreign Portfolio Investors) Regulations, 2019 (2019 Regulations) with a number of changes (as suggested by the committee headed by Mr. HR Khan), some to concepts dating back to the regime under the 1995 Regulations. The 2019 Regulations also consolidate the extensive guidance and requirements prescribed by SEBI by way of amendments to the 2014 Regulations as well as circulars and FAQs issued thereunder.

This post discusses some of the key aspects of the 2019 Regulations

Merging of Categories

SEBI has brought down the number of categories from three to two and modified the underlying criteria. While erstwhile Category I investors remain firmly in place, new additions include pension and university funds, and appropriately regulated entities such as banks, asset managers, investment managers, etc.

Things get more complicated when funds come into the picture. While earlier entities identified by the Financial Action Task Force (FATF) in their public statements could not become FPIs, membership of the FATF is now a make-or-break criteria for funds wishing to register as Category I. The following options are available:

• Appropriately regulated funds from FATF member countries.
• Unregulated funds from FATF member countries, with registered Category I investment managers.
• Entities with registered Category I investment manager (being from FATF member country), or at least 75% cent owned, directly or indirectly by another eligible entity from an FATF member country.

Category II is the new residual category and includes other funds, foundations, charitable organisations, corporate bodies, family offices, individuals, etc.

Some distinctions between Category I and II are laid down in the 2019 Regulations and some will have to be clarified through operational guidelines and specific instructions (such as in relation to position limits). A couple of significant differences are below:

Qualified Institutional Buyer Status: The SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 have also been amended such that the exclusions earlier applicable to Category III FPIs (mainly from the status of QIBs), now apply to FPIs which are individuals, corporate bodies and family offices. All other categories of FPIs shall continue to have the benefit of Qualified Institutional Buyer (QIB) status. This would not change much for other Category I and II FPIs, who will continue to enjoy the benefits of their QIB status.

Know Your Client Norms: The other great differentiator between Categories I, II and III was the risk-based Know Your Client (KYC) assessment. Category III was subject to the highest standard of KYC requirements. While the changes made to the ICDR Regulations are an indicator of how different entities within Category II may be treated differently, as of now, the operational guidelines/ further guidance have not been publically issued to DDPs. Expanding the extent of KYC for erstwhile Category II FPIs will be at odds with SEBI's efforts to ease the applicable norms and changes may be introduced with this in mind.

Broad Based Criteria

The requirement for funds to be broad based also does not find any mention in the 2019 Regulations. This is, of course, a significant departure from the 1995 Regulations, in which investment managers were necessarily required to have at least one broad-based client. This will certainly make the route attractive to new investors. Concerns that arose now and then on exit of investors will also be alleviated. The previous norms were deemed complicated and confusing by many potential investors and the market should benefit from this change.

Opaque Structures

The concept of opaque structures has now been done away with. It may be noted that an entity could fall outside the scope of "opaque structures" where information regarding beneficial owners was accessible. The law on identification and verification of beneficial owners has been significantly tightened and considered by SEBI and the HR Khan Committee in the past few months and the main concerns that SEBI had tried to address in the erstwhile opaque structure-related provisions should now stand addressed under separate provisions.

How Does It Impact On-going Business in Offshore Derivative Instruments?

Many eyes are on the implications of the 2019 Regulations on Offshore Derivative Instruments (ODIs) and with good reason. SEBI's effort to ensure parity between eligibility for the FPI and ODI route continues. However, re-jigging the categorisation has brought about some significant changes.

All Category I FPIs are eligible to issue ODIs to Category I eligible entities. Note that Category I now includes funds relying on the regulated status of their investment managers. This class was specifically prohibited from dealing in ODIs under the 2014 Regulations. After initially relenting and permitting grandfathering of existing positions, SEBI had ordered timely winding down of all such positions. However, the window is now open again, albeit just for entities from FATF members or through relying on an investment manager or eligible entities from FATF members.

Lost in the shuffle is the ability of regulated funds from non-FATF jurisdictions to deal in ODIs, chief among them being regulated funds from Mauritius. While not an FATF member, Mauritius is a member of the Eastern and Southern Africa Anti-Money Laundering Group (ESSAMLG). FATF is an international observer of ESSAMLG and had endorsed the evaluation of ESSAMLG on Mauritius' compliance with FATF recommendations. The question that then remains is: if an entity from a country that is in compliance with FATF recommendations and recognised as such by the FATF itself, and is otherwise a member of an AML compliance group (albeit regional), why should such an entity remain outside the scope of eligible entities?

Thus, ODI issuers will need to take a relook at eligible entities. The implications of these changes on existing positions is not clear and will have to be addressed to avoid any kneejerk reactions from the market.

Conclusion

Like all new regulations, the proof of the pudding will be in the eating. Issues will certainly crop up, like they are bound to in a dynamic market. SEBI has taken some bold and far- reaching steps and stepped out of its comfort zone to make the route more attractive. What is now required is mitigation of possible collateral damage to some bona fide players.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.