In a move towards lighter-touch regime, 80% FPIs classified as Category-I

Prior to the reclassification, less than 3% of the FPIs were part of Category-I and more than four-fifths were part of Category-II.

Nearly 80 per cent of foreign portfolio investors (FPIs) have been classified as Category-I, hinting at a far more liberalised regime for these investors. This may mean easier access, simplified know-your-customer (KYC) and documentation requirements, and fewer investment restrictions for a majority of FPIs, especially broad-based funds and pooled vehicles that were earlier part of Category-II. Prior to the reclassification, less than 3 per cent of the FPIs were part of Category-I and more than four-fifths were part of Category-II. About 13 per cent of the funds were classified as Category-III. 

FPIs in Category-II will not be able to subscribe and issue offshore derivative instruments. The compliance burden will be higher than Category-I. 

“The regulator appears to have considerably liberalised the FPI regime, with easier KYC and documentation requirements for a majority of the funds after the HR Khan Committee recommendations,” said Viraj Kulkarni, founder and chief executive officer, Pivot Management Consulting, adding, “Category-II FPIs have an incentive to comply with the requirements and move to Category-I as well.”

Category-II and Category-III funds faced considerable challenges in complying with documentation requirements earlier, increasing the cost of coming into India, he added. 

The KYC review, for instance, had to be done annually for Category-II and Category-III FPIs from high-risk jurisdictions. For others, KYC review had to be done at the time of extension of FPI registration. Category-III FPIs had to mandatorily submit financial data that included audited annual financial statements or net worth certificates from the auditor.

“We are moving towards a lighter-touch regime, but it remains to be seen if the norms for the new Category-I will be more liberal than the erstwhile Category-II,” said Anish Thacker, partner, EY India.

FPIs from at least four jurisdictions — Mauritius, Cayman Islands, Cyprus, and British Virgin Islands — are at a considerable disadvantage after the reclassification. Cumulatively, 83 per cent, or 767 of the 924 FPIs from these regions, are listed in Category-II, shows data from the National Securities Depository. 
 

Recently, officials from Mauritius’ financial services regulator Financial Services Commission (FSC) met those from the Securities and Exchange Board of India (Sebi), asking the latter to reconsider its stance of allowing only Financial Action Task Force (FATF) members to be eligible for Category-I. FSC officials told Sebi to tweak its existing guidelines to allow funds from FATF-compliant regions to register as Category-I FPIs.

Close to a third of FPIs from Singapore and the Netherlands are in Category-II as well. Experts said these are likely to be single-owned funds, or unregulated funds with unregulated fund managers. Other top FPI jurisdictions like the UK, Ireland, Canada, Norway, and Japan have less than 10 per cent of FPIs in Category-II. 

According to a report by Deloitte, the reclassification may provide significant relief to FPIs, primarily from the perspective of KYC requirements. Category-III FPIs could benefit from higher position limits in derivatives, eligibility to qualify as qualified institutional buyers, etc. 

Some of the potential advantages, however, may not be extended to individuals, family offices, and corporate bodies even after their reclassification, says Deloitte. Further, the advantages would be subject to any new restrictions imposed on Category-II FPIs under the income-tax law or the relevant Sebi regulations.

Sebi’s operating guidelines are expected to shed light on some of these issues. It is also not clear if some of the funds from regions such as Mauritius and Cayman will be shifted to Category-I before the regulator brings out these guidelines. 

Last month, Sebi merged the three FPI categories into two. Category-I includes central banks, sovereign wealth funds, pension funds, banks, asset managers, portfolio managers, and entities from FATF member countries. Category-II comprises corporate bodies, charitable organisations, family offices, individuals, and unregulated funds in the form of limited partnerships and trusts.