What the new FPI regulations entail for investment in India

Suresh Swamy/Nehal D Sampat | Updated on January 16, 2020 Published on January 16, 2020

While the rejig in classification of foreign investors raises some questions, most of the new regulations will help improve the ease of investing in India

With a view to ease the regime for investments by foreign portfolio investors (FPIs), the Securities and Exchange Board of India (SEBI) had notified the new SEBI (FPI) Regulations, 2019 in September, replacing the erstwhile SEBI (FPI) Regulations, 2014.

In order to provide clarity on the new regulations, SEBI has issued operational guidelines for FPIs and DDPs. Most of these changes are in line with the recommendations of the working group constituted by SEBI under the chairmanship of HR Khan.

Re-categorisation of entities

The new regulations have categorised FPIs based on regulatory status and country of residence — that is, whether the entity is from a Financial Action Task Force (FATF) member country. The operating guidelines have provided guidance on re-categorisation of FPIs. While Category-I FPIs under the erstwhile regulations would remain the same, the former Category-II FPIs have been re-characterised as Category-I or -II depending upon their eligibility.

All Category-III FPIs under the erstwhile regulations have been re-characterised as Category-II. Where such Category-III FPIs are eligible to obtain a Category-I registration (say on account of a regulated investment manager from FATF member country), they may make an application. There could, however, be additional tax compliance burden in India for the investment manager of such an FPI, in case it is required to register as a non-investing FPI.

The aforesaid change could impact entities from non-FATF member countries such as Mauritius, the Cayman Islands, the UAE, Taiwan, etc., who may have been Category-II FPIs under the earlier regulations but would not be eligible to obtain Category-I registration now. There are several benefits for entities registered as a Category-I FPI as against Category-II. Mauritian funds account for nearly 13 per cent of the entire AUM of FPIs investing in India, most of which would now be regarded as Category-II.

Last year, in a high-level meeting between SEBI and the Financial Services Commission (FSC) of Mauritius, SEBI had assured that it would not come out with a list of ‘high-risk jurisdictions’ to monitor capital inflows and will not identify Mauritius as such a ‘high-risk jurisdiction’. However, the new regulations seem to indirectly subject Mauritius entities to greater scrutiny. It needs to be seen how FSC will react to this.

The operational guidelines have defined an ‘entity from an FATF member country’ as one whose “primary place of business” is in such a country. This may lead to subjective interpretation in certain cases, say where a Mauritius entity has an investment manager in Singapore. While further clarity is awaited in this regard, it may be reasonable to assume the country of incorporation of the entity as its primary place of business.

Tightening investment norms

Another major change is the restrictions on issue/subscription of offshore derivative instruments (ODIs) for Category-II FPIs. ODIs (such as p-notes) are instruments used by the foreign investors to get exposure to Indian securities without registering with SEBI or undertaking any compliances. Only Category-I FPIs are now allowed to issue/subscribe to ODIs.

SEBI has been, in the recent past, tightening rules for purchase of securities in Indian companies through the ODI route, and has also encouraged direct investment in India by relaxing investment norms. The total exposure through p-notes as a percentage to the total AUM of FPIs has decreased from 55.7 per cent in June 2007 to less than 10 per cent in April 2016, eventually falling to 2.3 per cent in October 2019.

The operating guidelines provide that FPIs will not be allowed to issue ODIs referencing derivatives, similar to the earlier regime. FPIs can, however, take derivative position for the “hedging of equity shares” held by it in India, on a one-to-one basis. FPIs are also allowed to hedge ODI referencing equity shares with derivative positions, subject to prescribed position limits.

It may be interesting to note that SEBI had, in the last month, liberalised norms for issuance of depository receipts (DRs). DRs are foreign-currency denominated instruments issued by Indian companies listed on the international stock exchanges. Such DRs may serve as an alternative for entities intending to take exposure to Indian markets.

A few other changes include allowing certain appropriate regulated entities to invest on behalf of their clients by taking a separate FPI registration. Clients of such FPIs can, however, be only individuals and family offices. SEBI has also relaxed various KYC/BO requirements for FPIs.

The government has undertaken various measures to improve ease of doing business in India. In the latest World Bank’s ease of doing business ranking, India has jumped 14 places to take the 63rd position.

About 80 per cent of the FPIs have now been re-categorised as Category-I, which means that majority of FPIs will benefit from the new regime. These changes should go a long way to improve ease of investments in Indian public markets.

Swamy is Partner and Sampat is Executive Director-Financial Services Tax, PwC India. With inputs from Vijay Morarka, Manager, PwC India. Views are personal

Published on January 16, 2020
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