In the last few weeks, till the time SEBI gave a clarification, the hottest topic of discussion in the market was the SEBI April circular which put restrictions on Non resident Indians and Overseas Corporate Bodies (OCBs) from having beneficial ownership of FPIs. As we are aware, there are 3 categories of FPIs in India. While the Category 1 deals with sovereign funds, central banks and university endowments, the Category 2 deals with the regular portfolio managers and mutual fund. Then there is Category 3 which is the residual category. Most of the funds owned predominantly by NRIs or OCBs are in Category 3 and some are in Category 2.
The main purpose of the April 2018 circular was to ensure that better KYC is done of these FPIs so that the ultimate beneficial owner is known with greater clarity. SEBI has for long suspected that a lot of the money that comes through the FPI route is nothing but the money that goes out of India and then comes channelled back through the FPI route into India. Effectively, this was resulting in round tripping of funds which was imposing a huge cost on the Indian economy because it was moving money without any cost attached to it. The whole purpose of the April circular was to ensure more stringent KYC norms implemented so that in every FPI case, the actual face behind the veil is seen.
How reasonable is the $75 billion outflow threat?
The markets actually got jittery when some of the FPIs warned that government that the April circular would effectively make $75 billion worth of investments in India untenable and will have to be pulled out by the effective date of 31st December 2018. This was what actually led to the panic in the market. It also led to partial dilution by the government which subsequently allowed NRIs and OCBs to be ultimate beneficial owners of these entities provided the stake did not exceed 25% overall.
But did the circular really say anything new?
Actually, the April circular was not a new announcement but just a reiteration of the already existing policy of detailed KYC requirements for Category 2 and Category 3 FPIs. Category 1 is exempt from the detailed KYC requirement. A closer look at the April 10 circular shows that the concerns expressed by the FPI lobby group were largely unsubstantiated and there was hardly any need to worry about a $75 billion outflow. The circular was largely a reiteration of the rules already in existence in FPI Regulations, 2014. Let us look at some of the key ingredients of the circular and what it really means for the flow of foreign investments into India.
NRIs are barred from putting proprietary money, not from managing money
Unlike what was widely reported in the press, the SEBI circular had never talked about disallowing NRIs, OCBs and OCIs from managing investments on behalf of foreign investors. The restriction only applied to NRI and OCBs bringing in their proprietary funds into India. There is not restriction on NRIs and OCBs managing money on behalf of their foreign clients. There has really been no regulatory change on that front. In fact, the April circular clearly states that NRIs and OCIs can own FPI entities managing foreign money, providing they were a non-investing entity. The idea was to keep an arm’s length relationship between the NRI and the FPI. In case of NRIs and OCBs, they are still allowed to manage money on behalf of the FPIs; they only cannot own the FPIs since that tantamount to a direct investment in India through the back door. That is what the government wants to avoid. The whole idea is that if significant part of the investment is proprietary funds; that would make these investment managers also beneficial owners. It is only that part of the assets that needs to be liquidated and nothing else.
NRIs cannot be beneficial owners and that has been the consistent stand of SEBI
The April circular laid down that NRIs and OCIs cannot be beneficial owners in FPIs. Therefore, any structure that has NRIs and OCIs as beneficial owners (BO) have to be necessarily liquidated. But this is absolutely consonant with the FPI regulations as modified in 2014 when the categorization of FPIs was first decided. According to FPI regulations 2014, NRIs and OCIs cannot register as FPIs with SEBI. If these investors are permitted to hold substantial stake in FPIs it would be akin to giving a back-door entry into Indian markets. Unlike what is being portrayed by the FPI lobbying bodies, the April circular does not in any way bar FPIs that have NRI investments.
It is all about getting beyond the veil to see the real face
Ultimately, the SEBI circular pertains to stricter adherence to PMLA guidelines which has been the top priority for the RBI and SEBI. When the ultimate beneficiary is not identifiable, it becomes a multi layered structure and it becomes a test case for money laundering. That is what the regulator is looking to avoid. The basic intent of the April circular is only to identify the human face which is the ultimate owner of each FPI.
In a nutshell, it has been a case of much ado about nothing. A lot of ink has been spilt over an issue that is anything but contentious. Of course, the government and SEBI may be cautious considering the vulnerability of the rupee. Otherwise, the regulator appears to be on the right track. There really cannot be a big compromise on compliance.
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