A fresh fracas broke out last week with Foreign Portfolio Investors protesting over the provisions in SEBI’s circular of April 10. A lobby group of FPIs petitioned SEBI and the Centre to review these guidelines, stating that implementation of the rules could lead to around $75 billion of funds flowing out of the country.

SEBI asked the working group headed by Harun R. Khan to look into the concerns expressed by the FPIs and give suggestions. The group put out a discussion paper last weekend, which appears to have assuaged sentiments to a large extent.

But a closer look at the April 10 circular shows that the concerns expressed by the FPI lobby group were overblown. The circular was only reiterating rules already in existence in FPI Regulations, 2014 and in the related FAQs. A more lucidly written guideline might have helped avoid much of the confusion.

NRIs as investment managers

A lot of air-space was devoted last week to the lobby group protesting over how a ‘racist’ SEBI had disallowed Non-Resident Indians (NRIs), Overseas Citizens of India (OCIs) and Resident Indians (RIs) from managing investments on behalf of foreign investors. “If foreigners are allowed as investment managers for FPI money, why should Indians be debarred?” they argued.

But the April 10 circular clearly states that NRIs and OCIs could own FPI entities that managed foreign money, as a strictly non-investing entity. The circular read, “if an FPI is Category II investment manager of other FPIs and is a non-investing entity, it may be promoted by NRIs/ OCIs.”

The April circular was, in fact, only repeating the rules in the FPI regulations framed in 2014. These permitted entities owned by NRIs and resident Indians to be registered as non-investing FPIs, for the purpose of acting as an investment manager for other FPIs.

In other words, SEBI never had an objection to NRIs and RIs managing FPI funds, provided they did not invest their own funds through such entities.

So, Indian asset managers such as Motilal Oswal, Kotak, Edelweiss, SBI, UTI, and DSP Blackrock, among others, whose FPI arms have raised money from Indians residing overseas and other foreign investors, and are investing this money in India, do not really have to shut shop as long as they are only acting as investment managers.

The problem could arise if significant part of the investment is proprietary funds; that would make these investment managers also beneficial owners. That part of the assets will have to be liquidated within a specified time limit.

NRIs as beneficial owners

Another grouse of the FPIs with the April circular was that it laid down that NRIs and OCIs cannot be beneficial owners in FPIs. The circular says that any structure that has these entities as beneficial owners has to be wound down or liquidated.

SEBI is not wrong in asking these entities not to hold significant stake in FPI structures. According to FPI regulations 2014, NRIs and OCIs cannot register as FPIs with SEBI. Allowing these investors to hold substantial stake in FPIs would be akin to allowing them a back-door entry into Indian markets.

The maximum permissible ceiling for investment in a stock is also different for FPIs and NRIs — the limit is 24 per cent of the paid-up capital of the Indian company for FPIs and 10 per cent for NRIs. It needs to be noted that NRIs and OCIs can invest in Indian markets through FPIs, provided their investment does not cross a specified threshold.

Hence the perception in many sections that “the SEBI circular barred FPI entities with NRI investments” is also not correct.

Identifying beneficial owners

We all know that both the RBI and the SEBI are worried about money round-tripping through multi-layered FPI entities, where the ultimate beneficiary is not identifiable. The primary intention of the April 10 circular was to identify a ‘natural person’, which means a human, as the ultimate owner of each FPI. The owners’ details such as passport number, address, ID proof and so on were to be disclosed.

The April circular tried to pin the beneficial owner (BO) of each FPI by using the rules laid down in the Prevention of Money Laundering Act (PMLA) — BO is a person/persons owning or controlling 25 per cent of the FPI if the investor is a company and 15 per cent if the investor is a partnership firm, trust and unincorporated association of persons.

The working group has acknowledged that it might not be right to use the PMLA rules for identifying beneficial ownership. It has, therefore, recommended that the threshold for identifying BOs can be 25 per cent of the assets under management in case of a single NRI/OCI/RI. Aggregate holdings of these entities should be below 50 per cent of the AUM. The increased threshold appears reasonable enough. In case these entities hold more than the prescribed limit, all they would have to do is to liquidate the portion of assets exceeding the limit, or transfer it to someone else.

Investment managers as BOs

Another contentious clause in the April circular was: where the beneficial owner was not identifiable using the holding, entitlement or control method, then the investment manager was identified as the beneficial owner. If the FPI had NRI/OCI/RI as investment manager, then it’s existence could have been threatened.

But the working group has softened this clause too by stating that, there is no restriction on these entities from acting as investment managers.

While this leeway will provide relief to the protesting FPIs, ambiguity still remains on the method through which to nail the beneficial owner, if this is not apparent through the ownership or control method.

The April 10 circular prescribes using the look-through principle to identify beneficial owners.

The discussion paper too agrees with this, but the manner in which the look through will be done is not clear.

Better clarity is needed in this aspect as many FPI structures are likely to have no single investor/investor group, holding above the threshold limit. Identifying the ultimate owner in such structures is the key to checking money laundering through this channel.

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