Sebi moots stricter framework for identifying FPI beneficial owners

Current threshold of 25% too high for certain categories of investors, fears the regulator

The Securities and Exchange Board of India (Sebi) is mooting a stricter framework for identifying “beneficial owners (BOs)” of foreign portfolio investment (FPI) in the country.

The regulator is studying the viability and impact of lowering the threshold for BOs for providing additional information, said people aware of the discussions.

FPIs (fund) are pooled vehicles that put money in domestic securities and are registered with Sebi, just like mutual funds here. Under the current framework, the beneficial ownership of all the entities that make significant contributions to the fund needs to be disclosed.

If the investor in the fund is a company, the threshold is set at 25 per cent (of the fund corpus), and in case it is a fund or a partnership firm, the threshold is 15 per cent. In case the FPI is domiciled in a “high-risk” jurisdiction, the threshold for all investors in that fund becomes 10 per cent.

For entities that breach these thresholds, the FPI has to submit KYC (know your customer) documents, which include the records of identity, address and financial status, to custodian banks, which facilitate foreign investment in the domestic market.

Sebi can seek or access the data of BOs in any fund if it suspects round-tripping or routing of investment using front-entities or complex structures have been formed in violation of the Prevention of Money Laundering Act (PMLA).

Obtaining BO data can help Sebi understand if the fund is adequately broad-based or is being controlled by nefarious entities. Sources said the issue of lowering the threshold was discussed at a recent meeting.

“Sebi is keen on reducing the threshold. However, the move is seeing some pushback from the industry as it will involve a lot of paperwork and impact several FPIs,” said a person privy to the discussions.

“The belief in Sebi is that the current threshold of 25 per cent is too high. Technically, an entity who is contributing 24.99 per cent of the fund corpus can exercise huge control without disclosing its identity fully.”

A stricter framework will lead to more transparency and ensure genuine foreign capital is accessing the market. Those opposed to the move say India’s FPI regime is already stricter than in other jurisdictions.

“Many countries allow omnibus structures for FPI. This allows anyone to easily move in and out of a fund. The Indian market doesn’t allow many investor-friendly structures. Instead of relaxing, if the structure is tightened, the regulatory overreach, while it will ensure more transparency, could discourage genuine investors,” said an official with a custodian.

Sources said the matter was taken up last month at a meeting of Sebi’s recently constituted FPIs advisory committee, chaired by former chief economic adviser K V Subramanian. The panel has been tasked with advising on issues related to investment and operations of foreign investors in the financial market.

In a circular in September 2018, Sebi had said FPIs had to comply with the beneficial ownership criterion under PMLA provisions and should be made applicable for KYC too. The rules prescribe thresholds for corporate and non-corporate entities. 

According to PMLA rules, the beneficial owner could be an investor or a shareholder of a fund house exercising control over the FPI.

Failure to submit beneficial ownership details within six months could invalidate registration and force a foreign investor to sell its Indian holdings.

“Considering that FPIs are largely offshore entities and considering their ‘risk-based’ classification as either Category I (largely institutional investors, regulated funds) and Category II, it may be appropriate if the ultimate BO thresholds are aligned to FPI categories, which is 25 per cent for Category I FPIs and 15 per cent for Category II FPIs (rather than corporate/non-corporate FPI),” said Bhavin Shah, partner, PwC.

THE FINE PRINT

• Beneficial owner (BO) could be an investor or a shareholder of a fund house who can exercise control over the FPI
• BOs need to be identified in accordance with PMLA rules
• These rules prescribe a threshold of 25% and 15% for corporate and non-corporate entities, respectively
• There is a lower threshold of 10% for FPIs domiciled in ‘high-risk’ jurisdictions
• Sebi wants to lower the threshold to get a better grip on BOs