How Foreign Portfolio Investors Stand To Gain From Easier SEBI Norms

The Securities and Exchange Board of India has eased operational constraints and compliance requirements for foreign portfolio investors.

The changes were approved by market regulator’s board on Wednesday.

Here’s what experts have to say on the revised regulations:

Relaxation In Broad-Basing Criteria

The existing SEBI regulations classified foreign portfolio investors into three distinct categories based on parameters like degree of regulation and shareholding. Mutual funds, investment trusts and insurance companies etc. were allowed registration under Category-II only if they fulfilled broad-basing requirements or were deemed to be broad-based under the regulations.

A fund was considered to be broad-based if it had at least 20 investors with no investor holding more than 49 percent of the shares in such funds. SEBI has now done away with the broad-basing requirement. This is contrary to the HR Khan committee report which had advocated for broadening of the requirement.

“Doing away with the broad-basing requirement would further improve the ease of access for institutional investors,” Siddharth Shah, partner at Khaitan & Co., told BloombergQuint. “The universe of deemed broad-based investors kept on expanding to cover insurance companies, banks, pension funds etc.”

Shah said investors such as university funds or endowments or even large mutual funds, hedge funds had to prove themselves to be broad-based to be classified under Category II and give an undertaking to continue fulfilling this at all times. This, he said, was clearly found onerous for many investors.

“The decision by SEBI to do away with the broad-basing requirement is a welcome move,” Richie Sancheti, head of Investment Funds at Nishith Desai Associates, told BloombergQuint. The market regulator, he said, seems to be taking feedback on where the pain points have been. “There have been significant number of FPI who have struggled to meet the broad-based criteria specially if a fund has been recently launched and is yet to be marketed to a broader base of investors.”

Recategorisation Of FPIs

SEBI had used a risk-based approach for classifying foreign portfolio investors into three broad categories. After a review of its existing mechanism, it has now decided to re-categorise them into two categories—I and II. This implies that Category III will be eliminated.

“The risk-based classification of FPIs especially between Category I and II, and only recognition of government entities or sovereign funds under Category I had artificially pushed many other similarly low-risk investors like pensions funds, university funds or endowments into Category II, signifying relatively higher risk weightage compared to Category I,” Shah explained. This, he said, was not essentially correct as these investors too were equally long term, well regulated, from Financial Action Task Force member jurisdictions.

“Since many institutional investors will now move to Category I, for the rest, the KYC standards being largely similar and now with the broad-based criteria gone, it makes sense to consolidate them under one category which would eliminate the need for a Category III,” Shah said. “This should greatly simplify the regime as well as the registration process.”

Agreed, Sancheti. “There are couple of significant advantages that were attached to being a Category II FPI, the key one being that you are looked in as an institutional investor as a class and accordingly, you are allowed to participate in several assets which are otherwise not open to Category III FPIs or non-institutional investors,” explained Sancheti. “The second big advantage was that a Category II FPI on a look-through basis is allowed to have indirect transfers which was a specific relaxation made for Category I and II FPIs.”

“It remains to be seen that by harmonising Category II & III, are we going to see a homogenised tax and other advantages equally spread out between the two categories,” he said.

Eligibility Of Central Banks Of Foreign Countries To Register As FPI

SEBI has recognised central banks as eligible entities for a foreign portfolio investor licence. The existing regulations, however, limit the eligibility to only those central banks which are members of the Bank of International Settlement.

Now the regulator has noted that central banks are long-term and low-risk investors which are directly managed by a government of a foreign country. Therefore, a non-BIS registered central bank would now be eligible for a foreign portfolio investor registration. “Currently there are around 60 central banks which are members of BIS whereas all other central banks from other jurisdictions were excluded,” Shah said. “Considering that any sovereign is eligible to apply for FPI license, it was only rational that the eligibility should also extend to all central banks rather than limiting it to BIS members.”

Simplification Of Documentary Requirements

SEBI also simplified documentation requirements for KYC. The existing regulations mandate an FPI to submit various documents like constituent documents, financials, board resolutions etc. While KYC requirements are more stringent for Category III FPIs, certain relaxations have been extended to Category I and II based on an undertaking that they would submit such documents when asked by the regulator.

The existing KYC requirements, according to Shah, had a lot of duplicity and unnecessary requirements which created sensitivity from a data privacy perspective and more importantly did not add to any further comfort. “The exercise undertaken should significantly simplify the ask as well as the process, thereby improving the processing time and easing the administrative burden without compromising on requisite information.”

The regulator is yet to notify the revised regulations, which will become effective at the date specified by it.