[Vaibhav is a student at Gujarat National Law University.]
The Adani Group's stocks appear to have weathered the storm caused by the Hindenburg report but the SEBI does not seem to be taking a backseat yet, aiming to prove the stronghold of its regulatory framework. In a fresh endeavour to enhance transparency and foster trust, SEBI has recently issued a consultation paper proposing additional disclosures from 'high-risk' foreign portfolio investors (FPIs). This move comes in response to SEBI's ongoing struggle to identify the economic stakeholders behind FPIs that have invested in Adani's stocks.
This article mulls into the changes set forth by SEBI [which go beyond Prevention of Money Laundering Act 2002 (PMLA), and the PML (Maintenance of Records) Rules 2005 (PML Rules)]. This article further explores the potential challenges that may arise in bringing these amendments to life.
SEBI, in its consultation paper, has flagged the following two issues:
Concentrated group investments by FPIs and potential circumvention of minimum public shareholding norms
SEBI has observed that certain FPI’s holdings are concentrated substantially in a single investee/group, sometimes remaining unchanged for long durations, thereby raising a concern that the promoters or other persons acting in concert are using the guise of FPIs to flout MPS norms, thereby increasing the risk of manipulation and fraudulent activities.
Potential misuse of FPI route to circumvent Press Note 3 stipulations
Vide Press Note 3 (PN3), the Government of India inter alia required that in the event (i) entities situated in countries sharing a land border with India; or (ii) beneficial owners of investments in India are situated in or are citizens of such countries, investment can be carried out only under the government route. As PN3 did not apply to FPIs, they could be used to circumvent the provisions under PN3. SEBI has observed that in certain instances, while the FPI is not based out of countries sharing a land border with India, its beneficial owners were based out of such countries.
In terms of the PMLA, a beneficial owner is “an individual who ultimately owns or controls a client of a reporting entity or the person on whose behalf a transaction is being conducted and includes a person who exercises ultimate effective control over a juridical person”. Further, the PML Rules specify thresholds based on ownership (10% for companies and trusts, and 15% for partnerships etc.), economic interest or control for identification of a beneficial owner. In the event no beneficial owner is determinable, the senior managing official is deemed to be the beneficial owner.
The SEBI (FPI) Regulations 2019 read with the Master Circular for FPIs inter alia required designated depository participants to identify the beneficial owners on a ‘look through basis’, in the event the materiality threshold is exceeded at the FPI level. SEBI has observed that most investors are usually below the specified materiality thresholds. It is possible that the same natural person holds a significant interest in the FPI through different investment entities, each of which do not individually cross the threshold.
Proposal Put Forth by SEBI
As discussed, the proposed measures focus on enhancing transparency and identifying high-risk FPIs based on objective criteria. Therefore, to achieve the said objective SEBI has proposed that within Category I and Category II FPI registrations, further categorisation may be done, as follows:
Government and government-related entities such as central banks, sovereign wealth funds etc.
Pension funds or public retail funds as defined under Regulation 22(4) with widespread and dispersed investors in such funds. Categorisation of such FPIs as moderate risk shall be subject to the ability of DDPs to independently validate and confirm the status of such FPIs as pension funds or public retail funds with a wide and diverse investor base.
All other FPIs.
It is proposed that if additional disclosures are required, the risk categorisation will be considered along with the quantum of investments by the FPI in a single corporate group or on the basis of the overall equity AUM.
Prevention of circumvention of MPS norms
It has been proposed that high-risk FPIs holding more than 50% of equity AUM in a single corporate group would be required to provide granular data of all entities with any ownership, economic interest, or control rights on a full look- through basis up to the level of all natural persons and/or public retail funds or large public listed entities. Additionally, any material change is to be notified to the DDP within 7 working days.
Moreover, high-risk FPIs would be required to bring down their exposure below 50% within 6 months. In case of breaches on an ongoing basis, it is proposed to provide a window of 10 days to bring down such concentration, failing which the additional disclosure requirements will kick in. It may also be noted that FPIs who have just begun investments be allowed to cross the 50% group concentration up to a period of 6 months, within which the concentration would have to be brought down. A similar leeway has been proposed in relation to FPIs which are in the process of winding down their investments.
Some reclassification has also been proposed as some high-risk FPIs with relatively small India-oriented AUM compared to their global AUM may be reclassified as moderate risk if their exposure to a single India-related corporate group remains below 25% of their overall AUM. These reclassified FPIs would be exempt from certain additional disclosure requirements.
Prevention of misuse of the FPI route for circumvention of PN3
It has been proposed that existing high-risk FPIs with an overall holding in Indian equity markets of over INR 25,000 crores would be required to comply with granular disclosure requirements within 6 months, failing which the FPI would be required to bring down its AUM. With respect to FPIs that cross the above threshold in the future, the timeline for complying with providing granular details is proposed to be 3 months, failing which the AUM would have to be brought down below INR 25,000 crores.
The outlined changes aimed at enhancing transparency and trust in the market have generated both optimism and concerns. While the intentions behind these proposed regulations are commendable, a closer examination reveals several challenges that could potentially undermine their effectiveness. These hurdles raise doubts regarding the practical impact of the regulations, leading to apprehensions about their efficacy and the extent of their actual benefits.
Conflicting confidentiality considerations
The requirement for FPIs to disclose granular information about their investors, disregarding existing rules and secrecy laws in their domicile jurisdictions, is highly contentious. From a broader point of view, on one hand the RBI and the Ministry of Finance has flatly refused any kind of inspection rights to the European Securities and Markets Authority to clearing corporations in India, while on the other hand, SEBI is asking investors to forego the rights conferred to them under the secrecy laws of their own country. Such inconsistencies raise questions about fairness, consistency, and reciprocity in the regulatory approach, warranting a more balanced framework that respects confidentiality concerns while ensuring transparency and trust in India’s financial markets. Additionally, these requirements can be challenged by entities located in other jurisdictions as violative of their local laws as well as their right to privacy.
A potential loophole: Uncovering a critical oversight
While SEBI has taken note of investor investing in an FPI via different investing entities keeping their share below the pre-defined threshold limit to be identified as beneficial owner, a significant concern looms large. SEBI might have failed to anticipate a scenario where investors channel their investments into a company through multiple FPIs, carefully ensuring that no single entity surpasses the 50% exposure threshold while keeping the fund size below INR 25,000 crores. This apparent loophole in the regulations poses a substantial challenge and could potentially undermine the integrity of the proposed changes, rendering them ineffective.
In terms of enforcement, the SEBI has shouldered the responsibility of getting the granular details of the investor to DDPs, but the DDP might not have access to any information beyond the legal ownership. This limitation may result in a dependence on FPIs to provide the necessary details, potentially compromising the accuracy and effectiveness of SEBI's enforcement efforts.
The industry's positive reception of SEBI's proposed amendments highlights the recognition of the need for enhanced transparency and trust in India's financial markets. However, the journey towards achieving these goals requires a concerted effort to address the challenges that lie ahead. By proactively tackling the aforesaid issues, the effectiveness of the proposed amendments can be maximized. It is through these proactive measures that the desired outcomes of fostering transparency and trust can be realised, ultimately benefiting the industry and strengthening India's financial ecosystem.