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Regulatory Alert: SEBI releases Operational Guidelines for implementing SEBI (FPI) Regulations, 2019

14 November 2019

Background:

The capital market regulator in India, namely Security Exchange and Board of India (‘SEBI’) introduced revised Foreign Portfolio Investor (‘FPI’) Regulations on 23 September 2019; namely the SEBI (Foreign Portfolio Investors) Regulations, 2019 (‘2019 Regulations’). These regulations have replaced the erstwhile SEBI (Foreign Portfolio Investors) Regulations, 2014 (‘2014 Regulations’). Keeping with the Indian Government’s inclination towards ‘ease of doing business in India’, the 2019 Regulations seek to simplify the regulatory framework for FPIs, as well as make it efficient and effective. The 2019 Regulations were notified after taking into consideration the recommendations provided in the Report submitted by the Working Group constituted by SEBI as well as public comments on the same.

On 5 November 2019; SEBI also notified the Operational Guidelines (‘OG’) to ensure the smooth implementation of the 2019 Regulations. The OG have been issued with the objective of consolidating the operational and other finer aspects of the 2019 Regulations. The OG now replace the existing Circulars, FAQs and other guidance issued by SEBI (a detailed list of all rescinded Circulars has been provided at Annexure A to the OG). However, directions / guidance issued by SEBI as are specifically applicable to FPIs continue to remain in force. The OG also provide template of various forms and declarations, for ease of reference by relevant stakeholders.

Key highlights

The OG have been segregated into the following 5 Parts:

Part A: FPI Registration Related Activities

Part B: Know Your Client (‘KYC’) Requirements for FPIs

Part C: Investment Conditions / Restriction on FPIs registered under 2019 Regulations

Part D: Issuance of Offshore Derivative Instruments (‘ODI’) by FPIs under 2019 Regulations

Part E: Guidelines for participation / functioning of Eligible Foreign Investors (‘EFIs’) in IFSC

A summary highlighting key aspects of each of the above parts is provided in the Annexure.

Key Takeaways:

Registration and Re-categorisation:

The 2019 Regulations have revamped the categorisation of FPIs and now have segregated eligible entities into 2 categories instead of 3. The ambit of Category I FPIs has been widened to include ‘appropriately regulated’ entities. Further, funds seeking an FPI registration are no longer required to be ‘broad based’.

While the 2019 Regulations seek to simplify the FPI registration and compliance landscape by reducing the number FPI categories, the OG bring more clarity on the scope of each category and the manner of re-categorisation of existing FPIs into the new categories. The 2019 Regulations as well as the OG notably place higher emphasis on an FPI applicant’s jurisdiction rather than its legal structure or investor composition. The OG also bring further clarity on the Multiple Investment Manager (‘MIM’) option provided to FPIs, by specifying that separate registrations can be obtained and separate DDPs can be appointed for each IM. The SEBI, vide multiple Circulars issued in 2018, had prescribed thresholds for investment and control by NRI / OCI / RI in eligible and registered FPIs. These continue to be adopted in the OG.

Further, while the 2019 Regulations permit only Category I FPIs to be issuers or subscribers of ODIs, the OG also prescribe lesser KYC requirements and higher position limits for trading in stock as well as stock index derivatives.

KYC Requirements

The OG have made the KYC process clearer and more comprehensive. Relaxations have been provided to certain KYC requirements like address proof and board resolution, where a POA granted to the custodian can be submitted instead. The OG also enable intermediaries to directly share KYC documents with banks and other intermediaries, thereby reducing the compliance burden on FPIs. The OG also provide guidelines for identification of Beneficial Owners (‘BOs’ i.e. the natural persons who ultimately own / control an FPI, to be identified as per relevant rules) and exempt Government and Government related entities registered as Category I FPIs from providing BO details. Higher onus has been put on custodians and intermediaries on aspects like data security and maintenance of KYC records.

Investment Conditions / Restrictions

The OG have aggregated various aspects notified by SEBI from time to time, regarding the scope and restrictions on investments made by FPIs. Additional areas for investment as provided under the 2019 Regulations also find mention in the OG. The OG also prescribe detailed procedures for monitoring investment limits for timely identification of potential breaches, as also for disinvestment of excess shares in case of actual breach. A notable addition is the ability provided by the OG to FPIs to treat their investments as FDI, in case the investment limits are breached. It is also pertinent to note that investment in debt securities will be governed by RBI directions as issued from time to time, rather than the OG.

Issuance of ODIs

Issue of ODIs referencing derivatives was prohibited by SEBI (except for hedging purposes) vide its earlier Circular dated 7 July 2017. However, the OG also prescribe thresholds for taking derivative positions to hedge ODI referencing equity shares. The OG clearly tabulated permitted activities under various scenarios, to amply clarify SEBI’s position on the aspect of issuing ODIs referencing derivatives.

Guidelines for EFIs

The SEBI had earlier issued Circular dated 4 January 2017 laying down guidelines for participation / functioning of Eligible Foreign Investors (‘EFIs’ i.e. foreign investors eligible to invest in IFSC) and FPIs in IFSC. The OG now bring additional clarity to these guidelines by providing explanations on the term ‘EFI’ and giving necessary directions for starting investment activities in IFSC. 

Concluding Remarks

The revised SEBI (FPI) Regulations, 2019 and the detailed Operational Guidelines reflect SEBI’s current perspective on portfolio investments in India by overseas investors and its efforts to keep abreast with global developments and investor activities. The new Operating Guidelines are likely to increase procedural and compliance requirements for all stakeholders. Clarity on some of the finer aspects of the Regulations would enable FPIs to take informed decisions with respect to portfolio investments.

Annexure: Summary of Key Aspects

Part A: FPI Registration Related Activities

  • As per the revised FPI Regulations, FPIs will be categorised under Category I and Category II as against 3 categories prescribed earlier. The OG explains the re-categorization process.
  • As per the OG, existing Category III FPIs under the 2014 Regulations will be re-categorized as Category II FPIs under the 2019 Regulations.
  • However, existing Category II FPIs under the 2014 Regulations will be deemed to have been registered as either Category I or Category II FPIs under the 2019 Regulations, depending on the satisfaction of prescribed eligibility criteria.
  • The re-categorisation for each type of FPI is tabulated below:

Existing Categories as per 2014 Regulations

New Categories as per the 2019 Regulations

Appropriately regulated broad based funds such as mutual funds, investment trusts, insurance/reinsurance companies;

  1.  All Insurance entities Category I;
  2. Funds from FATF member countries - Category I;
  3. Funds from non-FATF member countries – Category II

Appropriately regulated persons such as banks, asset management companies, investment managers / advisors, portfolio managers, broker dealers and swap dealers

All are re-categorized as Category I

University funds and pension funds

All are re-categorized as Category I

University related endowments already registered with the Board as foreign institutional investors or sub-accounts

All are re-categorized as Category I

Unregulated funds/entity categorized as Cat II

by virtue of Regulated Investment Manager also registered as Category II FPI

Unregulated funds/entity where regulated Investment Manager is from:

  1. FATF member country and also registered as Category I FPI – Category I;
  2. Non-FATF member country– Category II
  • The re-categorization will be done by NSDL in consultation with the respective Designated Depository Participants (DDPs).
  • Once the deemed re-categorization of the FPIs is done, any FPI seeking re-categorization from Category II to Category I can do so after providing the requisite information, documents and payment of applicable fees.
  • For determining the eligibility for new applicants as well as for re-categorization of existing FPIs, the DDP shall consider the various prescribed checks, pertaining to aspects such as country of incorporation, eligibility in case of Non-resident Indian (NRI) / overseas citizens of India (OCI) / resident Indians (RI) check, eligibility criteria under Regulation 4 of 2019 Regulations, eligibility as Category I FPI, whether subject to any regulation in home country, any past inappropriate action, etc.
  • Guidance for registration in relation to specific entities such as banks, insurance/reinsurance entity, pension funds etc. have been laid out.
  • The OG clarifies that only those applicants which are incorporated or established in IFSCs regulated by SEBI (IFSC) Guidelines, can avail the relaxations in eligibility criteria for registration as FPI.
  • Separate FPI registrations can be obtained for Multiple Investment Managers (‘MIM’), however, investments made under multiple registrations will be clubbed for monitoring the investment limits. In case of MIM structures, there should be external investment managers. The FPI can appoint different DDP for each such registration.
  • If an FPI registered under a particular category fails to comply with any of the eligibility requirements, it shall notify the DDP of this change so as to get re-classified under the appropriate category.
  • The prescribed thresholds for investment and control by Non-resident Indian (NRI) / overseas citizens of India (OCI) / resident Indians (RI) in eligible FPIs have been laid down in detail.

Part B: Know Your Client (‘KYC’) Requirements for FPIs

  • FPIs are required to submit KYC related documents based on their category. After the completion of the KYC process, the intermediary uploads the Form and other documents on the KRA portal for other market intermediaries to access and complete the KYC requirements.
  • The following KYC requirements have been prescribed:

Sr. No

Document Type

KYC Documentation Details

Category - I

Category - II

1

 

 

 

 

Applicant Level

Constitutive Docs (MoA, COI, prospectus etc.)

Required

Required

2

Proof of Address

Required

Required

3

PAN (Tax ID in India)

Required

Required

4

Board Resolution

Not required

Required

5

FATCA / CRS form

Required

Required

6

Form/ KYC Form

Required

Required

7

Authorised Signatories

List of Signatures

Required

Required

8

Ultimate Beneficial Owner (UBO)

List of UBO including the details of Intermediate Beneficial Owners (‘BOs’)

Required

Required

9

Proof of Identity

Not Required

Required

 

  • The KYC documents need to be shared with banks while opening bank accounts of the FPIs.
  • FPIs need to maintain a list of BOs in the prescribed format as laid out in the guidelines.
  • A periodic KYC review is to be undertaken to ensure that the documents or information available are up-to-date. The review of FPIs is conducted as per the categories under which they are registered.
  • The Custodian has to keep KYC details of the for a period of 5 years from the date of cessation of transactions with the said FPI.

Part C: Investment Conditions / Restriction on FPIs registered under SEBI (FPI) Regulations, 2019

  • Investments made by FPIs belonging to the same investor group will be clubbed to arrive at the investment limit applicable to a single FPI.
  • The combined holdings of FPIs from the same group should be below 10% of the total paid up equity capital in a listed or to-be-listed company on a fully diluted basis.
  • The depositories have to monitor on a daily basis the aggregate investment limits of the FPI group based on demat holdings data at end of day.
  • FPIs having multiple registration belonging to the same group shall request NSDL for information regarding the investment made by its group entities in any particular scrip before making investment decisions.
  • To ensure that foreign investment in a company is in compliance with the prescribed limits, whenever the foreign investment is 3% or less than 3% of the aggregate NRI/FPI limits or sectoral cap, a red flag will be activated.
  • Any investment held in excess of the investment limits shall be sold off within 5 trading days from the date of settlement of the transaction. The disinvestment shall be done as per the prescribed method.
  • FPIs are permitted to sell off-market unlisted, suspended, illiquid and delisted shares in accordance with the guidelines laid down by Foreign Exchange Management Act, 1999 (‘FEMA’) with regards to such sale.
  • FPIs can acquire “to be listed shares” pursuant to IPO, FPO, rights issue or private placement or shares consequential to a scheme of merger or demerger.
  • FPIs can invest in government securities, exchange traded currency, interest derivatives and corporate debt securities subject to complying the directions, terms and conditions specified by the RBI. FPIs investment in debt oriented mutual fund will be considered as investment in corporate debts.
  • The guidelines have laid down position limits for investment in stocks, stock index derivative contracts, interest rate futures, currency derivatives and currency derivatives contracts.
  • FPIs can also invest in units of REITs, InvITs and Category III AIFs as per SEBI (FPI) Regulations, 2019. However, an FPI shall not hold more than 25% of stake in Category III AIF.
  • If an FPI and / or its investor group reaches 10% or more of the total paid up equity capital of a company, they much follow applicable FEMA Regulations. Such group can opt to treat their investment as Foreign Direct Investment (‘FDI’) and the same shall be subject to FDI norms prescribed by the RBI. Once this option is adopted, no more portfolio investments can be made in the company. Further, the sale of such an investment would continue to be considered as an FPI sale.

Part D: Issuance of Offshore Derivative Instruments (‘ODI’) by Foreign Portfolio Investors under SEBI (FPI) Regulations, 2019

  • FPIs are not permitted to issue ODIs, referencing derivatives. FPIs are also not allowed to hedge their ODIs with derivative positions on stock exchanges in India. Certain exceptions have been made to these restrictions for Category I FPIs with separate FPI registration. The same are summarised below:

Sr. No.

ODI reference / underlying

ODI issuer’s holding in India against the ODI

Allowed

Exception

1

Cash equity/ debt securities / any permissible investment by FPI (other than derivatives)

Cash equity/ debt securities / any permissible investment by FPI (other than derivatives), for life of ODI

Yes

None.

Separate registration required to undertake any proprietary derivative transactions by such ODI issuing FPI.

2

Cash equity

Cash equity on date of writing the ODIs and then move to derivative positions thereafter.

No

Allowed through separate FPI registration, subject to 5% limit.

3

Cash equity

Derivative on date of writing the ODI or thereafter except in manner referred at (2) above in table.

No

None

4

Derivatives

Derivatives

No

Allowed through separate FPI registration, if FPI is holding cash equity and has short future position exactly against the cash equity in the same security (one-to-one basis).

FPI to retain the cash equity for the life of ODI.

5

Derivatives

Cash equity

No

None

 

  • An FPI issuing ODI which hedges its position by investing in securities (other than derivatives) cannot undertake proprietary derivative positions on the same registration. An FPI issuing ODI cannot mix its non-derivative proprietary investments and ODI hedge investments with its proprietary derivative investment or vice versa on the same FPI registration.
  • Fresh derivative position cannot be taken unless the above requirements are complied with. FPIs have been given 90 days from the date of notification of the OG to comply with the above requirements.
  • An ODI subscriber who has become ineligible under the new Regulation can continue to hold their positions till 31 December 2020, however, no renewal / rollover of existing positions will be permitted.
  • In line with 2014 Regulations, synthetic short activities continue to be prohibited for FPIs.
  • The issuer of the ODI should obtain sufficient documents / information to satisfy itself with regards to the relationship between the ODI subscriber and its Investment Manager from a FATF member country as per the Regulations.
  • The investments made by an investor as an FPI and also as an ODI subscriber will be clubbed to ascertain the investment restriction limits.
  • The ODI issuing FPIs should maintain appropriate KYC documents of its ODI subscribers and should be presented to the SEBI on demand.
  • FPIs issuing ODI shall identify and verify the BOs in the ODI subscriber entities. BOs and intermediated shareholder / owner entity holding investments equal and above the materiality level should be identified on a look through basis.

Part E: Guidelines for participation / functioning of Eligible Foreign Investors (‘EFIs’) in IFSC

  • EFIs operating in IFSC shall not be treated as entities regulated by SEBI.
  • SEBI registered FPIs proposing to operate in IFSC shall be permitted to operate without any additional documentation and / or prior approval.
  • EFIs are those foreign investors who are eligible to invest in IFSC and are not resident in India, not resident of a country black-listed as per FATF public statement and not prohibited from dealing in securities market in India.
  • The EFIs need to comply with the above eligibility criteria and prescribed KYC norms laid down in the OG, to start with investment activities.
  • FPIs already operating in India and proposing to operate in IFSC will require to have a clear segregation of funds and securities. The FPIs shall also inform their respective custodians about their participation in IFSC.