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SEBI’s Proposed FPI Norms: Will it lead to more transparency or just more paperwork?

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SEBI’s May 31 consultation paper proposing higher disclosure requirements for FPIs mark another attempt at unmasking ultimate beneficial ownership.

Besides clarity on what granular information is expected from FPIs, the question of enforcement remains tricky, given the international jurisdictions these entities operate from, and their complex structuring

The Hindenburg report may be a thing of the past, but its impact continues to be felt. On May 31,  SEBI issued a consultation paper proposing higher disclosure requirements for Foreign Portfolio Investors (FPIs). The purpose of these proposed norms is to prevent misuse of the FPI route, circumvention of minimum public shareholding (MPS) norms, and address certain foreign investments that require government approval.

SEBI’s pursuit of transparency in FPI ownership was evident earlier this year when it requested details of the ultimate beneficial owners from the Designated Depository Participants (DDPs) of FPIs. FPIs are registered by DDPs on behalf of SEBI. These DDPs are banks (17 in total) reporting to depositories (NSDL/CDSL) with multinational presence and compliance with FATF and PMLA standards.

Tracking High Risk FPIs

Now, SEBI has taken the next step by proposing mandatory additional disclosures for high-risk FPIs, specifically regarding their ownership, economic interest, and control. FPIs are categorised into three groups: low risk (predominantly owned by the respective government), medium risk (Pension Funds or Public Retail Funds as defined under FPI Regulations, 2019), and high risk (including all FPIs not falling under the other categories).

The consultation paper considers the ease of doing business and suggests that higher disclosure requirements should be linked to either the concentration of investments by FPIs in a single corporate group or the size of their overall equity assets under management (AUM).

Consequently, these norms would apply to high-risk FPIs holding more than 50 percent of their equity AUM in a single corporate group, posing a risk of violating minimum public shareholding (MPS) norms due to lack of transparency. However, even among these FPIs, if an FPI’s India-oriented assets under management (AUM) is relatively smaller than its global AUM and its exposure to the corporate group is less than 25 percent of its overall AUM for a scheme, it may be considered a moderate risk FPI. Exceptions are also proposed for new FPIs, FPIs in the winding-up process, or those experiencing momentary breaches.

SEBI’s second focus is on restrictions imposed on countries sharing borders with India, requiring prior government approval for investments. SEBI is concerned that lack of transparency in ultimate beneficial ownership could be exploited by investors from bordering countries who invest through FPIs situated in non-bordering countries to bypass the government’s approval process.

As a result, high-risk FPIs with an overall holding exceeding INR 25,000 crore would need to comply with granular disclosure requirements or reduce their AUM below the threshold. Again, if an FPI’s India-oriented AUM is relatively smaller than its global AUM, it may be considered a moderate risk FPI.

SEBI acknowledges that these additional norms will only impact around 6 percent of total FPI equity assets under management (AUM) and less than 1 percent of India’s total equity market capitalisation, alleviating concerns about broader adverse effects on the market. But this also means that these norms may be extended to other categories in future.

Quest For Transparency: Roadblocks Ahead

SEBI’s proposal demonstrates its ambition for transparency in the securities market and its aim to address the issues raised in the Hindenburg Report. However, implementing granular disclosures on ownership, economic interest, and control poses enforcement challenges. Identifying beneficial ownership without a materiality threshold, as proposed in the consultation paper, may face legal challenges in jurisdictions where the investors are located.

The proposal also lacks clarity on the specific granular information that SEBI expects from ultimate beneficial owners. While it is understandable that SEBI wants to maintain flexibility by leaving this aspect open-ended, some guidance would be beneficial. It remains uncertain whether SEBI will only require the name of the controlling individual, bank records, government identification, or if it expects banks to conduct thorough KYC procedures, or some no-objection from the regulator of local jurisdiction under IOSCO (International Organisation of Securities Commissions) framework would be needed.

Additionally, the proposal suggests reducing holdings, particularly for high-value, high-risk FPIs that fail to meet the granular disclosure requirements. This could lead some of these FPIs to sell their holdings to avoid being classified as high-risk FPIs.

Ultimately, the effectiveness of enforcing these provisions, if introduced, will depend on the complex structures of investor entities spread across various jurisdictions globally. In conclusion, transparency in securities markets is crucial for maintaining trust and addressing the concerns raised in the Hindenburg Report. However, it remains to be seen whether SEBI can successfully achieve its objectives and overcome the challenges that lie ahead.