Overseas investors plan to meet market regulator Securities and Exchange Board of India (Sebi) this week to seek clarity and highlight lacunae in the recent circular on foreign portfolio investors (FPIs).
In the circular, aimed to curb round-tripping, Sebi said the ultimate beneficiary of a fund will be determined by both shareholding and control. FPIs are currently allowed to invest up to 10 per cent in a listed Indian company. If the new beneficial test is applied, all the funds run by the same manager will be clubbed as they have the same beneficial owner and their combined investments in several companies could breach the FPI shareholding cap.
Until now, economic ownership has been the primary criteria for determining the beneficial owner of an offshore fund, which means an entity owning majority stake in a fund was considered the beneficial owner. But, in the new circular, Sebi asked FPIs to determine ownership on the basis of both shareholding and control.
In this context, ‘control’ means the right to appoint and remove directors, along with other administrative rights.
Several big-ticket FPIs such as Fidelity, Franklin Templeton Investment Advisors, Blackrock and Oppenheimer Funds use the ‘investment manager’ model, wherein they set up multiple funds to pool in money from investors.
While asset management companies (AMCs) don’t own any considerable stake in the funds, they control the funds by appointing investment officers, managing the day-to-day affairs.
Hence, if the new test is applied, all the funds will have to be aggregated. This would run the risk of these funds breaching the 10 per cent shareholding cap. “The development is an unintended fallout. Sebi's intention was purely to curb ownership of Indians and non-resident Indians in offshore funds. We are meeting Sebi officials in the coming week to seek clarity on the issue,” said a source, adding that the circular in its current form would have an adverse fallout. Further, in cases where the beneficial owner cannot be determined based on ownership stake or control, Sebi has said the senior managing official of the FPI will be considered the beneficial owner.
“In such situations, it could mean that if two FPIs have the same senior managing official though different beneficial owners, investments made by both FPIs would have to be clubbed for determining the 10 per cent limit. This could create unintended practical challenges in certain cases,” said Rajesh Gandhi, partner, Deloitte Haskins & Sells.
The Reserve Bank of India (RBI) amended the Foreign Exchange Management Act (Fema) in January pertaining to FPI investments in listed companies. According to the new rules, if the shareholding of an FPI exceeds 10 per cent in an individual company, the investment will be deemed as foreign direct investment (FDI). The FPI regime is simpler and cost effective for offshore investors putting in money for trading purposes. On the other hand, the FDI route is meant for strategic investments.
If any of the existing FPI investments breach the 10 per cent cap and become FDI investments, they would be subject to tax deduction at source (TDS) and will also be subject to trading curbs. Further, there are several restrictions on FDI investments in various sectors and hence, if any of such conversion from FPI to FDI breaches the sectoral cap, the fund will be forced to divest its stake in the company.
FPIs are the largest class of investors in terms of assets under management. The total assets under custody of FPIs in equity markets stood at Rs 28.7 trillion – more than three times the size of home-grown mutual funds.