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Sebi’s FPI mandate will be tricky to enforce, say experts

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The consultation paper states that the primary responsibility of monitoring the status regarding the concentration and size thresholds shall rest with the FPI.

High-risk foreign portfolio investors (FPIs), with assets of over Rs 25,000 crore in Indian equities, have come under regulatory scanner, but implementation could be a big challenge, say experts. The regulator has mandated additional granular disclosure requirements from such high-risk and large FPIs, who have more than 50% holding in one entity.

“The proposed amendments would result in disclosure down the rabbit hole to find the final beneficial owner in certain high risk investor categories, as Sebi has defined. While the move appears in line with need for higher transparency, it will pose one challenge in terms of enforcement,” tweeted Sandeep Parekh, founder and managing partner of Finsec Law Advisors.

The consultation paper states that the primary responsibility of monitoring the status regarding the concentration and size thresholds shall rest with the FPI. However, the responsibility of monitoring the same and informing the FPI in case of any breach of the threshold, followed by rectification of the same would rest with the designated depository participant (DDP) of the FPI.

Parekh pointed out that even though the DDP would be obliged to get details of the final person/fund/listed company, there would also be an obligation of obtaining economic interest or control. Considering these could be done by private agreements, the obligation would really be on the FPI itself, with no ability of the DDP to go beyond the legal ownership.

Sebi had reportedly reached out to DDPs earlier this year, for information regarding the ultimate beneficial owners of FPIs. It sought to put a check on firms purchasing their own shares via related entities based abroad.

“The proposal rests on the premise of ‘look-through basis’ to identify the ultimate natural person. It would require inapplicability of secrecy or privacy laws of offshore jurisdictions where investors are situated, which will be a challenge. Granular disclosures without materiality thresholds does question the relevance of materiality tests in the first place. However, it seems the paper is issued having noted the existence of ownership concerns of FPIs for many years,” says Manendra Singh, partner at Economic Laws Practice.

He said this will lead to managers going back to the drawing board and could result in restructuring at multiple levels in case of any grey areas. With the threat of closure in case of non-compliance within six months, it could pose a serious concern to larger FPIs. While the proposals are seen combating issues pertaining to purchasing shares via related parties and misuse of funds for price manipulation, some believe addition of extra provisions won’t serve the purpose.

“By ensuring transparency and curbing round-tripping, this initiative will not only safeguard investor interests but also strengthen tax administration. Many foreign funds and FPIs have struggled to establish ‘commercial substance’ or demonstrate ‘beneficial ownership’, leading to diversion of dividends to pass-through entities instead of their rightful owners. Effectiveness of the proposal ultimately depends on dedicated action rather than mere provisions, as a decade of enforcement against FPIs has revealed,” said Sumit Agrawal, partner at Regstreet Law Advisors.