Foreign Portfolio Investors (“FPI”) are now subject to a revised regulatory framework ( the “2019 Regulations”). These regulations were introduced with a primary aim of easing the registration process, liberalising the regulatory conditions, relaxing the compliance requirements and giving a boost to foreign investment in India.
Registration as FPI
SEBI (Foreign Portfolio Investors) Regulations 2014 (“2014 Regulations”) gave certain exemptions from registration to foreign institutional investors and qualified foreign investors. 2019 Regulations have eliminated these exemptions and require every person dealing in securities as FPI to mandatorily acquire a registration certificate from the Designated Depository Participant (“DDP”). Further, existing offshore funds set up by Indian mutual fund houses will now need to register themselves as FPIs by March 22, 2020.
FPIs will still need to obtain a permanent account number and undertake necessary to know your customer on its shareholders/investors with the rules applicable to it in the jurisdiction where it is organised. The FPI will further need to abide by the code of conduct prescribed under the 2019 Regulations and appoint a compliance officer for being responsible for monitoring the compliance under the SEBI Act.
Eligibility for registration as FPI
The 2019 Regulations have made substantial changes to the eligibility criteria to attract more investors and to ease the process of investment. Some of the key changes made to the eligibility criteria are:
Central Banks of Foreign Countries to be eligible to register as FPIs:
The Committee Report noted that central banks are long-term and low-risk investors which are directly managed by a government of a foreign country. The 2014 Regulations granted eligibility to only those central banks which are members of Bank of International Settlement (“BIS”). Through the 2019 Regulations, SEBI has recognised non-BIS registered central banks as eligible entities for an FPI license.
Broad-Based Criteria:
Under the 2014 Regulations, a fund could not be registered as an FPI if it did not qualify the broad-based criteria. A fund qualified as a broad-based fund if it had at least 20 investors with no investor holding more than 49% shares of the fund. The Committee Report suggested broadening this requirement but the 2019 Regulations have done away with this requirement. Eliminating this requirement will attract more investors which will eventually yield higher investments.
IFSC deemed to meet jurisdiction criteria
The 2019 Regulations provide that FPIs set up in the International Financial Services Centre (“IFSC”) shall be deemed to satisfy the jurisdiction criteria under Regulation 4 for registering as an FPI. An entity set up in an IFSC now qualifies to be registered as a FPI even though such an entity would be a domestic entity.
Investment limit
The FPI regulations provide for a threshold on the total investment in each company by the FPI including its investor group[1]. The 2014 Regulations provided for the investment threshold of 10 percent of the issued capital of the company. Under the 2019 Regulations, the threshold has now been changed to 10 percent of the ‘fully diluted paid-up equity capital’ [2] of a company. This increases the scope for investments by FPIs in the equity of companies.
Reclassification of categories of FPI
Classification of Category I
Under the 2014 Regulations, FPIs were classified into 3 categories with the easier compliance norms for Category-I FPIs and the strictest for Category-III FPIs. Under the new framework, SEBI decided to eliminate category III and to re-categorise into two categories, Category I and Category II FPIs.
Category I AIFs continues to include government and government-related investors such as central banks, governmental agencies, sovereign wealth funds, and international or multilateral organisations.
The entities which were registered as Category II FPIs will now be eligible to register as Category I FPIs. Further following entities will also be eligible to be registered as a Category I FPI:
The following entities set up in the Financial Action Task Force (“FATF”) member countries:
- Regulated funds;
- Unregulated funds whose investment manager (“IM”) is regulated and registered as a Category I FPI; and
- Endowments of a university that has been in existence for more than 5 years.
- Entities with registered Category I IM (being from FATF member country), or at least 75% cent owned, directly or indirectly by another eligible entity from a FATF member country.
Reclassification of Category II
Category II FPIs is a miscellaneous category which includes all the investors not eligible under Categories I FPIs such as (a) endowments and foundations; (b) charitable organisations; (c) corporate bodies; (d) family offices; (e) individuals; (f) appropriately regulated entities investing on behalf of their client; and (g) unregulated funds in the form of limited partnership and trusts.
Under the 2014 Regulations, Category III AIFs had to comply with the strictest KYC requirements. The re-categorisation is likely to provide substantial relief to FPIs from the perspective of KYC requirements.
Investment funds seeking Category I FPI registration are now required to be from the FATF member countries only, with certain exceptions. Funds established in non-FATF member jurisdictions may now qualify under Category II FPI.
Removal of opaque structure conditions
In the erstwhile framework, DDPs had to ensure that FPIs do not have an opaque structure. The objective of this restriction was to preclude entities where beneficial owner information was not available or accessible. The 2019 Regulations have eliminated the opaque structure condition.
Off-market transactions
SEBI has now permitted FPIs to transfer any unlisted, suspended or liquid securities off-market. The Committee Report recommended authorising such off-market transactions between FPIs and domestic investors only, SEBI has further allowed such off-market transactions with foreign investors as well.
Conclusion
India has observed strong foreign outflows in the recent past. SEBI, with an aim to attract more overseas funds and central banks into the Indian market, has liberalised and simplified the regulatory framework for FPIs. By easing the compliance norms, especially through the removal of broad-based criteria, SEBI has tried to incentivise the investors. Elimination of investment restrictions is expected to attract smaller and recently established funds to invest in India.
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Footnotes:
[1] Multiple entities registered as an FPI and directly, having common ownership of more than 50% or common control, shall be treated as part of the same investor group and the investment limits of all such entities shall be clubbed at the investment limit as applicable to an FPI.
[2] ‘Fully diluted basis’ means the total number of shares that would be outstanding if all possible sources of conversion are exercised.
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