Being one of the fastest growing major economies in the world as well being one of the largest in terms of GDP and purchasing power parity, India has evolved as a major destination as far as global investment flows are concerned. Investment by foreign investors in Indian securities including shares, government bonds, corporate bonds, convertible securities, infrastructure securities etc. are directed through portfolio investment route[1]. This class of foreign investors, who make investment in such securities, are known as Foreign Portfolio Investors (FPIs) whose registration, classification and investment conditions are regulated by SEBI.

With the growing participation of FPIs in the Indian capital markets, the regulatory framework governing the FPIs have witnessed several changes in the past. However, the year 2019 has seen a major transformation in the regulatory regime governing the FPIs in the wake of SEBI (Foreign Portfolio Investors) Regulations, 2019 (“FPI Regulations 2019“), notified on September 23, 2019, thereby superseding the erstwhile FPI Regulations 2014.

Further, the FPI Regulations were supplemented by the Operational Guidelines for FPIs, Designated Depository Participants and Eligible Foreign Investors (“Operational Guidelines“) issued vide circular dated November 05, 2019 to facilitate implementation of the FPI Regulations 2019.

Revamping the FPI regulations – reasons

The process of revamping the FPI regulations began in March 2018 after the government began to have a crackdown on black money and tightening of anti-money laundering laws.

SEBI had constituted a Working Group[2] with a view to overhaul the regulatory framework for FPI, primarily to simplify and liberalise the regulatory regime. In alignment with the anti-money laundering rules, SEBI issued a circular dated April 10, 2018 thereby revising the KYC requirements for the FPIs which though created quite a stir amongst the foreign investors and their advisors. As per this circular the beneficial ownership (BO) criteria under money laundering rules was made applicable to eligibility criteria for FPIs, including those having Non Resident Indians (NRIs) /Overseas Citizens of India (OCIs)/ Resident Indians (RIs) as their constituents. Resultantly, serious apprehensions were created with respect to the clubbing of investment limit for FPIs and status of an NRI/OCI/RI as a Senior Managing Official of FPI.

Thereafter, SEBI requested the Working Group to examine issues arising out of the said SEBI circular dated April 10, 2018 to meet the twin objectives of having:

1. Robust anti-money laundering rules and at the same time
2. Ensuring investor-friendly ecosystem.

On the basis of the recommendations of the Working Group, SEBI issued FPI Regulations 2019 and the Operational Guidelines supplementing the FPI Regulations 2019.

Key highlights of the FPI Regulations 2019 are enumerated hereunder.

Re-categorization of FPIs

Under the FPI Regulations 2019, the categorization of FPIs has been simplified and the now the number of categories of FPIs have been reduced to 2 from 3 as were under erstwhile FPI regulations.

Category I FPIs and Category III FPIs under the erstwhile FPI regulations are re-categorised as Category I FPIs and Category II FPIs respectively, under the FPI Regulations 2019.

The Category II FPIs under the erstwhile regulations have now been re-categorised as Category I FPI and Category II FPIs under the FPI Regulations 2019, subject to fulfilment of the eligibility requirements.

A major reshuffle in the categories of FPI has been on account of removal of broad-based criteria and inclusion of entities identified by Financial Action Task Force (FATF) member countries, in the eligibility criteria for registration as FPI under the FPI Regulations 2019.

Broad Based Criteria

Under the erstwhile FPI regulations, certain funds, whether appropriately regulated or unregulated, were required to satisfy the broad based[3] criteria for seeking registration as FPI.

However, under the FPI Regulations 2019, such requirements have been done-away with entirely, to the cheer of foreign investors. This is widely expected to provide an added sheen to the FPI route as this has been a pain point for several investors till now. What this does is that any fund having less than 20 investors would also be able to apply for registration as FPI, albeit subject to fulfillment of other compliances.

Removal of restriction on opaque structures

Pursuant to the erstwhile FPI regulations, FPIs were not permitted to have opaque structures such as protected cell company or segregated portfolio company (SPC) or equivalent, where the details of the beneficial owners were not accessible or where the beneficial owners are ring fenced from each other or where the beneficial owners are ring fenced with regard to enforcement, unless the FPI satisfied certain conditions.

The FPI Regulations 2019 have lifted such restrictions, being one of the long-standing wishes of the investing fraternity. This has been enabled by virtue of ever evolving anti-money laundering laws whereby the FPIs are already required to provide declaration/disclosures with respect to the ultimate beneficial owners of each sub-fund/share class/ equivalent structure that invests in India.

This can safely be expected to result in cost optimization for fund/investment structures taking advantage of such segregated liability structures.

Appropriately regulated entities investing on behalf of their clients

The FPI Regulations 2019 permitted Appropriately Regulated Entities such as banks and merchant banks, asset management companies, investment managers, investment advisors, portfolio managers, insurance and reinsurance entities, broker dealers and swap dealers to undertake investments on behalf of their clients as Category II FPIs in addition to undertaking proprietary investment by taking separate registrations as Category I FPI.

However, such registration is subject to attainment of certain conditions such as the clients of FPI should only be individuals and family offices which shall not be dealing on behalf of a third party and fulfilling certain KYC requirements.

Offshore funds of Mutual Funds to register as FPIs

An offshore fund floated by an asset management company that has received no-objection certificate in accordance with the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, is now required to obtain registration, for investment in securities in India, as a FPI within 180 days from the date of notification of the FPI Regulations 2019.

NRI and OCI participation in FPIs

Under the FPI Regulations 2019, Non-resident Indians (NRIs) or Overseas Citizens of India (OCIs) or Resident Indian (RI) individuals can also be constituents of the FPI provided they meet conditions specified by SEBI from time-to-time.

FPIs vis-à-vis the Non-Debt Instruments Rules makes a couple of key changes governing FPI investments into Indian companies

The recently enacted Non-Debt Instruments Rules, replacing the erstwhile FEMA TISPRO Regulations, provides certain changes as regards the FPIs.

With effect from 1st April 2020, the investment limit by FPI in an Indian company would be the sectoral cap. Earlier, the limit was 24%, which could be enhanced by the company by passing necessary resolutions. Where the Indian offshore company formation wishes to reduce the FPI limits to a lower threshold, such companies would need to do so before March 31, 2020. Once the limits are enhanced, the Indian company cannot reduce the limits.

In cases where FDI is prohibited, the FPI limit is capped at 24% of the company’s paid-up equity capital on a fully diluted basis.

Conclusion

The simplification of the categorization, registration and compliances by FPIs has seemingly reduced the complexities in relation to making portfolio investments in India and made the environment more conducive for FPI investment. The key takeaways are undoubtedly the removal of broad-based criteria, opaque structures and allowing entities identified by FATF member countries for registration as FPI.

This ideally should make investments in India more attractive and less cumbersome for foreign investors. Although the FPI regime has certainly received some regulatory booster shots, it still remains to be seen as to whether the new FPI regime will provide a new fillip to the FPI.

Having said so, it certainly is a step in the right direction from the lawmakers in its pursuit to make India a pro-investor destination and enhancing India’s charm globally.

Citations:

[1] Under this route, FPIs are allowed to invest only in listed securities. Further, investment by a FPI cannot exceed 10 per cent of the paid up capital of an Indian Company and all FPI taken together cannot acquire more than 24 per cent of the paid up capital of an Indian Company.

[2] Working Group committee chaired by Mr. Harun R. Khan.

[3] Broad Based Fund means a fund, established or incorporated outside India, which has at least twenty investors, with no investor holding more than forty-nine per cent of the shares or units of the fund.

Authors:

The article is authored by Rajeev Nair, Principal Associate, Rajani Associates and Nishant Sogani, Associate, Rajani Associates.