In 2022-23, the whispers intensified into a crescendo amid reports that a few foreign portfolio investors (or FPIs, the new term for FIIs) had parked a substantial part of their corpuses in stocks of Adani group companies. The plot thickened in late January when the Wall Street short-seller Hindenburg hurled damning allegations against the group. Old questions resurfaced and rattled the market: who are the real faces, the actual persons in flesh and blood, to pop up once the layers above the FPI vehicle are peeled off?
On Wednesday, the Securities & Exchange Board of India (Sebi) took the matter head on — or, was probably forced to. The timing of the Hindenburg report was critical because in November the Financial Action Task Force (FATF), a global body to combat money laundering, will review India. Any adverse comments by FATF, which sought New Delhi responses to more than 300 questions, can impact inflows.
Against the backdrop of Hindenburg’s allegations of stock price manipulation and the coming FATF review, Sebi has proposed a new set of rules to track the ‘last natural persons’ or the ultimate beneficial owners (UBO) in an FPI. Given the turn of events, one may assume that the proposals in the Sebi consultation paper would become new regulations.
Today, a foreign individual who is unwilling to disclose her identity can remain below the radar by contributing less than 10% in the FPI fund pool. Sebi plans to do away with this regulatory threshold for funds that would be categorised as ‘high-risk’ based on certain parameters. Once a fund is tagged as ‘high-risk’ it would have to reveal the identities of all the natural persons who own and control the fund behind the layers.
As per the proposal, FPIs that have deployed 50% or more of its money in the stocks of any single business group, or whose aggregate exposure to the Indian market is over Rs 25,000 crore (around $3 billion), will have to make this detailed disclosure. Only when the FPI is owned by a publicly listed company or a public retail fund, the ultimate beneficial owners need not be named.FPIs typically pool funds in places like Cayman Islands and Delaware, and trade in emerging markets like India through vehicles in jurisdictions like Mauritius and Singapore which have tax treaties with India. The FPI chain can be structured to mask the real owners. For instance, if a Cayman company in an FPI chain holds 40% in the Mauritius vehicle and there are multiple investors, each owning less than 25%, in the Cayman entity, then the regulator would never get to know the firms or people beyond Cayman. Since everyone in the Cayman entity has an interest below 25%, none of their economic interest in the Mauritius entity exceeds the regulatory cut off limit of 10%.This threshold (lowered from 25 to 10% recently) was fixed in 2018 to align the disclosure guidelines with the rules under the Prevention of Money Laundering Act. It was largely aimed to simplify rules for FPIs, the largest investor group in the stock market. Before that it was left to the custodian banks of FPIs to decide the threshold; and, if required Sebi could ask for UBO details of an FPI. However, today Sebi faces the 10% disclosure hurdle, which it is trying to overcome through a set of onerous rules that may not go down well with many FPIs — even the kosher ones.
The dubious funds would hire the best lawyers to devise new structures while bona fide UBOs who are paranoid about privacy and closely guard their investments, would be put off by a demanding regulator. It could also push many foreign investors to take the P-note route about which the consultation is silent. P-notes, or participatory notes, are offshore derivative instruments issued by FPIs to foreign investors who want to bet on Indian equities without registering themselves with Sebi. While FPIs have to share the details of P-note holders, a P-note investor may cut deals with several funds and hold below the 10% threshold in each to stay unnoticed. Will Sebi tighten the P-note rules as well?
And, is all this too much, too late? As the Tamils say, “Kan Ketta piragu Surya Namaskaaram” (It’s no use praying to the Sun God after you go blind). Sebi, however, finds itself in a spot. It has to give a finality to the Adani probe, preserve its reputation, change the rules if needed, convince FATF as well as keep alive the interest of FPIs. It can only hope that the price would not be too high.
