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Tightening of the FPI regime – Is it a move in the right direction?

Finsec Law Advisors

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SEBI vide a circular dated April 10, 2018 (“April Circular”), inter alia barred non-resident Indians (“NRIs”) and overseas citizens of India (“OCIs”) from being beneficial owners (“BOs”) of a foreign portfolio investor (“FPI”). The April Circular raised apprehensions among the NRI/OCI community as foreign funds managed/controlled by NRIs/OCIs may have had to exit the Indian securities market

The April Circular borrowed the definition of BOs from 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 have been laid down in the April Circular, namely, i) the economic interest test, and ii) the control test. Under the economic interest test, an NRI/OCI 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 NRI/OCI will be considered to exercise control over an entity if he has control over the affairs of the FPI, including having management rights. Imposing a blanket ban on NRIs/OCIs based on the aforesaid tests may have unintended consequences. For instance, an OCI who is an investment manager and has intricate knowledge about the Indian securities market will now be barred from managing an FPI, even if he has no economic interest in the firm except for receiving remuneration for managing the fund.

The working group headed by Mr. H R Khan constituted to review inter alia the April Circular, has in its interim report (“IR”) addressed some of these concerns of the stakeholders. The IR has recommended that the definition of BO should be used to identify NRIs/OCIs strictly for the purposes of KYC requirements and such NRIs/OCIs should not be restricted from being constituents of FPIs. According to the new eligibility criteria recommended in the IR, NRIs/OCIs should be permitted to be constituents of FPIs provided their percentage holdings in the asset under management of the FPIs stays below the prescribed threshold.

However, the IR endorses the “control test” and recommends that NRIs/OCIs should not be in control of an FPI. Under such circumstances, NRIs/OCIs who satisfy the “control test” by inter alia holding ‘management shares’ or ‘management rights’ in an FPI shall be barred from managing such an FPI, even if they enjoy no controlling ownership interest.

Although the IR has allayed the fears of market participants, the concern highlighted above ought to be considered by SEBI.