The problem of money belonging to Indian entities being ‘round-tripped’ through shell companies in offshore tax havens is not a new one. Despite regulatory tightening over the years, loopholes are exploited to conceal the beneficial owners of the shell companies.
The Hindenburg research report on the Adani group has once again called attention to this issue, pointing out that the latter had 38 shell companies in Mauritius besides other such brass-plate entities in Cyprus, the UAE, Singapore and Caribbean islands through which money was being round-tripped into listed as well as unlisted companies in the group.
It is just as well that the stock market regulator, Securities and Exchange Board of India (SEBI), is beginning to act on this important issue. A report in this newspaper said that the regulator has asked designated depository participants to update details pertaining to the beneficial owners of all foreign portfolio investors onboarded by them, by September 30. FPIs which do not comply could have their registrations cancelled.
The problem is that many of these FPIs are structured as multi-layered entities where it is easy to conceal the ultimate owner of the company. In 2018, SEBI tried to tighten norms by laying down that a ‘natural person’ should be the ultimate owner of FPI. The owner’s details such as address, ID and passport had to be collected and held by the custodians and given to regulatory authorities during investigations.
Identification of beneficial owners was based on Rule 9 of the Prevention of Money-laundering (Maintenance of Records) Rules, 2005, wherein companies owning more than 25 per cent of the FPI or individuals, partnership firms, trusts and unincorporated association of persons owning 15 per cent of the FPI were identified as beneficial owner. In case a BO could not be identified through ownership or control, the investment manager had to be identified as the BO and his details provided to the depository.
But the Adani episode seems to suggest that it is still possible to evade identification by maintaining ownership and control beneath the threshold limit or by using other entities as facades to evade identification.
SEBI needs to apply the ‘look through’ principle in such cases, where following the letter of law may not prove adequate. Stringent penalties should be imposed on market intermediaries abetting such fund flows; they should be banned from markets altogether. SEBI should also reduce the time given to FPIs to disclose the BO to three months.
Also of concern is the new report that a bear cartel based overseas, took short position in Adani stocks in the domestic market through the use of structured product derivatives (SPDs), which are issued to these investors by FPIs registered with SEBI.
If overseas traders are able to create a rout amounting to $100 billion in Adani shares, without a presence in India, this poses a systemic risk. SEBI will have to take a closer look at SPDs — rules governing their issuance, entities to whom they can be issued, stock and market level thresholds, etc.