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After the Hindenburg-Adani saga, market watchdog Sebi has proposed to tighten disclosure standards for high-risk foreign portfolio investors (FPI) that own more than 50 per cent or more of their equity assets under management (AUM) in a single corporate entity.
Such FPIs will have to make additional disclosures around the ownership of, economic interest in, and control of such funds.
Sebi, in a consultation paper, said on Wednesday proposals are aimed at preventing possible circumvention of minimum public shareholding (MPS) requirements and potential misuse of the FPI route to guard against the inherent risks of the opportunistic takeover of Indian companies.
Sebi is also trying to prevent overseas entities from indirectly controlling Indian firms through a chain of shell companies.
The proposal comes months after US-based short seller Hindenburg Research alleged in a report that some FPIs held a significant stake in the listed companies of the Adani Group. Hindenburg also alleged that some FPIs were fronts of the promoter entities. Sebi hit a dead end when it came to identifying the end beneficiaries at certain FPIs.
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The regulator’s paper has proposed to categorise FPIs into high, moderate and low risk.
* Low risk: Government entities such as sovereign funds and central bank funds will qualify
* Moderate risk: Pension or public retail funds with a diverse investor base
* High risk: All other FPIs
Who is impacted
All FPIs except for government and government-related entities, such as central banks, sovereign wealth funds, and pension funds or public retail funds, are proposed to be categorised as high-risk FPIs. According to Sebi, FPI AUM of Rs 2.6 trillion, or 6 per cent of total FPI equity AUM, and less than 1 per cent of Indian equity market capitalisation may potentially be identified as high-risk FPIs as of March 2023.
High-risk FPIs will have to provide complete details of the operational structure if they hold more than 50 per cent in a single group.
For entities with moderate risk, the onus is on the designated depository participants or custodians to validate and confirm the status of such entities as pension or public retail funds with a wide and diverse investor base.
“Sebi has been mindful of the need to walk the tightrope between the need to ensure trust and transparency and the need to ensure ease of doing business in India. Accordingly, additional disclosures are proposed to be obtained only from the FPIs categorised as high risk, which also fulfil other criteria as specified,” said Suresh Swamy, partner, Price Waterhouse & Co.
Sebi’s proposal
FPIs with an exposure of more than 50 per cent to a single group or with assets of over Rs 25,000 crore will be tagged as ‘high risk’ and will be required to provide additional information such as full identification of their ownership, economic interests, and control rights. They will have to follow the new norms within six months, failing which the FPI will have to bring down its AUM below the threshold within a time frame. Moreover, failure to provide these disclosures will lead to the invalidation of the FPI registration.
Hindenburg Research alleged that Adani Group used FPIs as fronts to hold shares in listed companies, taking actual promoter shareholdings beyond the maximum promoter limit of 75 per cent. As the Business Standard editorial notes, the Sebi consultation paper "boils down to seeking the actual beneficial owners of shares held by an FPI, which has a concentrated portfolio. It tightens the disclosure requirements about beneficial ownership, which had earlier been relaxed."
FPI circumvention?
Four Mauritius-based FPIs were found to have invested almost all of their capital in Adani Group stocks. The four FPIs were named in Hindenburg Research’s report, which alleged that they were used to shore up the stock prices of Adani Group stocks. When Sebi conducted its probe, it was unable to zero in on the ultimate owners of these FPIs.
"Through the proposed changes, SEBI intends to maintain free float in the public shareholding of listed companies and keep the prices of such shares subject to free market forces instead of manipulation," said Raj Bhalla, partner at law firm MV Kini.
“Some FPIs have been observed to concentrate a substantial portion of their equity portfolio in a single investee company/ company group. In some cases, these concentrated holdings have also been near static and maintained for a long time. Such concentrated investments raise the concern and possibility that promoters of such corporate groups, or other investors acting in concert, could be using the FPI route for circumventing regulatory requirements such as that of maintaining Minimum Public Shareholding (MPS),” said the Sebi consultation paper.
If this were the case, the apparent free float in a listed company may not be its true free float, increasing the risk of price manipulation in such scrips, noted Sebi. In order to ensure that there is no such circumvention of MPS or other related regulations, Sebi thinks it is necessary to obtain granular information from FPIs. If FPIs are made to reveal details about the beneficiary owners/ultimate beneficiaries, then it becomes easier to investigate if these entities have any links to the promoter group.
The government amended the foreign direct investment (FDI) policy through a Press Note 3 (2020) on April 17, 2020 to check opportunistic takeovers of stressed Indian companies at a cheaper valuation. Through a press note it was made mandatory that an entity of a country that shares land border with India, or where the beneficial owner of an investment into India is situated in or is a citizen of any such country, can invest only under the Government route.
Sebi is worried that FPIs may be used as a front to conceal ownership of Indian shares by entities in such countries
"While Press Note 3 is not applicable to FPI investments, the FPI route could potentially be misused to circumvent the stipulations of Press Note 3. To this end, there is a need to identify investors in high-risk FPIs with large equity portfolios at a granular level, whose investors may be based out of land bordering countries. In certain instances, it has been observed that while the high-risk FPI itself may be situated out of a non–land bordering country, the investors in such high-risk FPIs may be based out of land –bordering countries," noted Sebi.
"SEBI is apprehensive, that investors from land bordering countries could be using the FPI route instead of the mandated government route, since FPIs are exempt from PN3 requirements. In certain instances, SEBI has observed that while an FPI itself may be situated out of a non–land bordering country, the investors in such high-risk FPIs may be based out of land–bordering countries. Thus, in this backdrop, SEBI aims to prevent misuse of PN3 requirements by entities based out of land bordering countries," said Raj Bhalla, Partner at law firm MV Kini.
SEBI also fears that FPIs could potentially be misused for circumventing the requirements under the PMLA by avoiding the disclosure of the true identity of the beneficial owner. "Therefore, additional KYC disclosures are required to be implemented. Since this will involve deeper disclosures, to remove difficulties instead of proposing the additional KYC requirements for all FPIs, to maintain balance, SEBI is proposing to categorise the FPIs in 3 categories," said Rohit Jain, managing partner, Singhania & Co.
FPIs discouraged?
“On the face of it the proposal may appear to be discouraging to the concerned FPIs, but it is necessary to know for the regulator / enforcement agencies and public shareholders, if any such FPIs are acting as “front” for the promoter(s) of a listed company," said Yogesh Chande, Partner, Shardul Amarchand Mangaldas and Co.
The new proposal will be difficult to implement
“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 the need for higher transparency, it will pose one challenge in terms of enforcement,” said Sandeep Parekh, founder and managing partner of Finsec Law Advisors, on Twitter.
"While the Depository Participant is obliged to get the details of the final person/fund/listed company, there is also an obligation of obtaining economic interest or control. Since these could be done by private agreements, the obligation would really be on the FPI, with no ability of the Depository Participant to go beyond the legal ownership," said Parekh.
High-risk FPIs will re-look at their investments and restructure holdings
“Investors will feel jittery about the information being disclosed about their structures, especially where different jurisdictions are used to deploy funds. FPIs that could fall within the realm of ‘high-risk FPIs’ would surely have a relook at their investors and flow of monies, to either be able to disclose or wind up or cease to be a high-risk FPI,” said Manendra Singh, partner at Economic Laws Practice.
“There have been instances where FPIs have eyed a particular company or a group for long-term exposure. Thus, we may see some structuring of FPI investments into India, pursuant to these recommendations. Sebi may still question FPIs even after structuring their investment to bring it within the concentration limit, if Sebi thinks that the FPIs are deliberately trying to keep their investment into respective Indian company or a group close to the concentration limit,” said Dhaval Jariwala, partner, PNDJ & Associates. (Read more here)
"Momentum seen in FPI flows in the past two months could slow down in the near term, but normalise once compliances are in place. These measures are right steps to improve governance standards and ownership quality in Indian Companies. Would also help improve investor confidence in the market and avert situations seen in the first quarter of the year," said Rajesh Cheruvu, Managing Director and Chief Investment Officer, LGT Wealth India.
Relaxation to existing FPIs might be a loophole
"The relaxation to the existing FPIs to cross the 50 per cent group concentration up to a period of 6 months and the opportunity to existing FIPs to wound down their investments will enable high-risk FPIs to yet again evade from rendering 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 Public Retail Funds or large public listed entities. While the proposal put forward by SEBI is the right step to ensure transparency and to protect the interest of the investors, however, at the same time the categorization and relaxation embedded under the proposals continue to put the investment of the investors under risk identified by SEBI," said Siddharth Joshi, Senior Associate, SKV Law Offices.
The Congress party on Thursday demanded that Sebi should ensure complete disclosure of ownership of foreign portfolio investors from retrospective effect. It said that only a parliamentary committee (JPC) can probe to ascertain who diluted and then removed the very rule in this regard to benefit the Adani group. In a tweet, Congress leader Jairam Ramesh said, "The SEBI Consultation Paper put out yesterday proposes to tighten the very rules it was forced to dilute in 2018 to allow foreign portfolio investors to invest in Indian companies without having to reveal their FULL ownership details. This was done to benefit Modani." "We hope the Consultation paper is not an eyewash exercise and will cover investments made earlier," he said.
Siddharth Joshi, Senior Associate, SKV Law Offices, believes Sebi has already addressed this concern. "Sebi has ensured that the additional disclosures as required under the framework would also be made applicable to the existing high-risk FPIs in the event the existing FPIs do not bring down their 50 per cent holding in a single corporate group within a period of 6 months then the existing FPIs will need to provide additional disclosures," he said.
