Home >> Blog >> Strict Know Your Clients (KYC) Norms for Foreign Portfolio Investors- Is Clamour Justified?
06 Sep 2018

Strict Know Your Clients (KYC) Norms for Foreign Portfolio Investors- Is Clamour Justified?

The genesis of Foreign Portfolio Investor (FPI) can be traced to SEBI (Foreign Portfolio Investors) Regulations, 2014 (FPI Regulations). FPI Regulations consolidated the investments of foreigners in Indian Capital Market which was till then scattered under Foreign Institutional Investors and Qualified Foreign Investor route. The object clause of the FPI Regulations state that it is to put in place a framework for registration and procedures with regard to foreign investors who propose to make portfolio investment in India.

The criteria set out for registration as FPI amongst others categorically says that the applicant cannot be a Non-Resident Indian (NRI) and applicant should be person not resident in India. A look at these criteria along with object clause makes it abundantly clear that FPI route is not envisaged for an NRI and this route is set out way back in 2014.

The General obligations applicable to FPIs state that Designated Depository Participant(DDP) (DDP registers FPI on behalf of SEBI) can demand for documents to ensure compliance with Prevention of Money Laundering Act, 2002 and rules made thereunder.

Similarly, provisions are in place concerning beneficial ownership in FPI Regulations. It provides for reporting on any change in Beneficial Ownership or to look at Beneficial Ownership when determining compliance with investment limits applicable to FPI or in order to determine if FPI are created as opaque structures (opaque structures are prohibited).

Further, the Frequently Asked Questions (FAQ) applicable to FPI, clarifying various aspects regarding FPI clearly state under various replies that a company which are majority owned by NRI/PIO cannot invest through FPI route and it has been quoted that the position is same as it was under Foreign Institutional Investor (FII) regime. They can register as Category 2 FPI for providing investment management services.

The April 10, 2018 circular of SEBI on Know Your Client norms has actually given life to the Rule 9 of Prevention of Money Laundering (Maintenance of Records) Rules, 2005. This being the case, the general concepts which were already covered under various regulations, i.e. FPI route is only for Foreign Investors and especially the provision regarding general obligation, imposing obligation on DDP to monitor compliance with the PMLA and its rules has been enforced under the said circular.

The rule 9(3) of the said PML (Maintenance of Records) Rules, 2005 has defined beneficial owner almost on similar lines. It has stated that where the client is a company, the beneficial owner is the natural person(s), who, whether acting alone or

together, or through one or more juridical person, has a controlling ownership interest or who exercises control through other means. It is explained that “Controlling ownership interest” means ownership of or entitlement to more than 25 per cent. of shares or capital or profits of the company and “Control” shall include the right to appoint majority of the directors or to control the management or policy decisions including by virtue of their shareholding or management rights or shareholders agreements or voting agreements.

Thanks to DDPs for their long slumber while onboarding and verification done continuously regarding registered FPIs and SEBI’s circular dated April 10, 2018 providing time limit of six months for compliance (extended to December now), it looks that the violators had sufficient time to make it grow to an extent which can have a systemic effect regarding Foreign Investments by NRI dominated FPIs.

It cannot be denied from a business perspective that NRI/PIO who are familiar with Indian Markets can sell Indian Capital Market to foreigners better and for building trust factor, an effective investment from their end would also be necessary. However, how much is required to build that trust factor i.e. whether more than 25% of paid up capital in a company need to be held by NRI/PIOs is a larger question, which needs to be thoroughly considered by the committee looking to review FPI process.

It is to be noted that anti-concentration norms have been placed by SEBI and RBI in order ensure that these investments are really a portfolio investment and does not take the colour of FDI. The regulatory challenge in this regard, may be as to how one would address concentration of investments in a particular company and how one can avoid its negative effects, if at all beneficial ownership is not identified and enforced in letter and spirit?

Yet another issue which may be a concern for regulators are regarding sovereign obligations to repay foreign investments (by FPIs) under international law. In order to address these concerns, it is suggested, the regulators may look at creating fund structures specifically catering to NRIs/PIOs with sufficient safeguards. As of now, there is no particular fund structure catering to specific needs of NRI/PIO community.

Now, seeing at the figures of 75bn dollars said to be affected as published by leading newspapers, that too as a front-page news after a long time of 4 months from publication of alleged Circular raises serious concerns to general investors. This figure of 75bn dollars seems to be referring to the total investments made by FPIs in Indian Capital Market though no clarity is given by them in this regard. If the figures given out by SEBI on FPI investments as reported in the SEBI Bulletin (August) is seen, it shows that FPIs have total assets of Rs.33,34,518 Crores in India as on July 2018. It is stated that FPIs have invested Rs.2264 crores in July, 2018 in equity opposed to selloff in previous three consecutive months (April, May and June, 2018). The positive July,

2018 trend seen from figures quoted by SEBI bulletin (August) tells us a different story regarding FPI investments from what is reported in Newspapers. Ethically, it is expected from national level newspapers to report without bias and to put forth all facts for readers to make a judgement.

To conclude, the clamour of NRI dominated FPIs that it’s a sudden policy change is not true. It seems even in absence of Apirl 10, 2018 circular of SEBI, it was obligated on FPIs to be truly a body controlled and owned by foreign investors. Although, it is a different pitch as to whether NRI /PIOs have to be allowed to invest through a dedicated Fund Structure. At this time it is good for NRIs- Investment Managers to stand by national interests rather than put their self-interest at front.

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