As a policy shift, SEBI vide circular dated April 10, 2018 (“April Circular”), had provided that clubbing of investment limit for FPIs for investment in Indian companies (below 10% of the paid-up capital) shall be based on the definition of beneficial owners (“BOs”) as laid down in Rule 9 of the Prevention of Money-laundering (Maintenance of Records) Rules, 2005 (“PMLA Rules”). To determine whether an individual is a BO, two primary tests were laid down in the April Circular namely, i) the economic interest test, and ii) the control test. Under the economic interest test, an individual is considered to enjoy economic interest over an entity if he holds a minimum controlling ownership interest in the entity. Under the control test, an individual is considered to exercise control over an entity if he has control over the affairs of the FPI, including having management rights. This raised concerns for the FPI sector as the norms for clubbing investments would also apply to cases were common investment managers would manage different FPIs without enjoying any economic interest in them. Such investment managers would also include several OCIs/NRIs who have in-depth understanding of the Indian Securities market.
As the FPI sector raised concerns, a working group headed by Mr. H R Khan (“WR”) was constituted to review the April 10 Circular. The WR in its interim report recommended that clubbing of investment limit of FPIs should not be determined based on common senior managerial officials (“SMOs”). Further the WR also recommended that the common control test should not be applied to public retail funds which include entities such as mutual funds which are open for subscription for retail investors. SEBI partially accepted the recommendations of the WR and issued a circular dated December 13, 2018 (“December Circular”) to revise the framework.
Under the December Circular, clubbing of investment limit of FPIs would be done based on common ownership (of more than 50%) or common control. However the test of common control would not be applied to certain public retail funds (“PRF”) which are appropriated regulated. In case of breach of investment limits the concerned FPIs, can i) divest their holding within five trading days from the date of settlement of the trades or ii) the investment could be treated as an FDI from the date of breach. This measured decision of SEBI to relax investment norms for FPIs is a move in the right direction, however, the common control test will continue to apply to FPIs which fail to qualify within the definition of PRFs.