Dawn of a new regime for foreign portfolio investors

The Securities and Exchange Board of India (SEBI) notified the SEBI (Foreign Portfolio Investors) Regulations, 2014, on 7 January, merging the legal regimes for foreign institutional investors (FIIs) and qualified foreign investors (QFIs) into a single regime for foreign portfolio investors (FPIs).

Though most offshore private equity (PE) funds invest under the foreign direct investment (FDI) or foreign venture capital investment window, PE funds sometimes also invest in listed securities. For such investments, the new FPI regime would be of significant relevance.

Existing FIIs/sub-accounts and QFIs may continue to operate under the FPI regime on the payment of a conversion fee. However, awaiting corresponding changes to the Reserve Bank of India regulations, SEBI has kept the window open for transactions by existing FIIs/sub-accounts and for fresh registrations by prospective investors until 31 March 2014, extendable until 30 June 2014.

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Registration

The FPI regulations shift the onus of registering an FPI with SEBI to designated depository participants (DDPs). The applicant must be a fit and proper person; resident outside India, but not a non-resident Indian; legally permitted to invest in offshore securities, including by its charter documents (for entities); with investment experience and a good track record.

The applicant’s country’s securities regulator must be a signatory to the International Organization of Securities Commissions’ Multilateral Memorandum of Understanding or to a bilateral memorandum of understanding with SEBI. For banks, the applicant’s resident country’s central bank must be a member of the Bank for International Settlements.

The applicant’s resident country cannot be among those cited by the Financial Action Task Force for certain anti-money laundering/combating the financing of terrorism deficiencies.

Subject to satisfaction of the conditions, the DDP must grant or reject registration within 30 days from application or provision of additional information. SEBI may clarify any disputes, interpretational issues and appeals against rejection within 30 days.

By removing the requirement to approach SEBI, FPI registration could be a significantly faster and streamlined exercise, which is crucial for deal timelines.

Categorization

Categorization of FPIs has been done on the basis of risk profiling. Category I would have the least know your customer (KYC) requirements and Category III the highest. Category I is for government and related entities; category II is for entities that are regulated or supervised by a securities market regulator or banking regulator and for unregulated broad-based funds with regulated investment managers; and category III is a residuary category.

The categorization eases KYC norms for investors such as sovereign wealth funds. PE funds that are not broadly based would fall under category III entailing more KYC, including a requirement to disclose ultimate beneficial owners, and sometimes the limited partners in the fund are extremely sensitive to such disclosure.

FPIs can invest only in listed and proposed-to-be-listed securities. Investments by a single investor or investor group (entities with same beneficial ownership) are capped at 10% of the equity share capital.

The FPI regulations allow all categories of FPIs to invest in all securities where FIIs are allowed to invest. Certain conditions are also broadly the same.

All unlisted investments will have to be made from a separate vehicle. Additionally, the aggregate cap of 10% for “investor group” entities could pose a challenge for groups having FDI interests in the same company under a different vehicle. As the intent may not have been to cover FDI investments, SEBI may need to clarify this. The uniform 10% investment limit could give significant headroom for funds with few investors.

All offshore derivative instruments (ODIs) issued under the FII regulations will be grandfathered. Category I and II FPIs (except unregulated broad-based funds) will be allowed to issue, subscribe to or otherwise deal in ODIs, directly or indirectly. Such ODIs may be issued only by or to persons who are regulated by an “appropriate foreign regulatory authority” (a term not defined by SEBI) subject to KYC norms.

Unregulated broad-based funds (with regulated investment managers) have been disallowed from issuing or subscribing to ODIs, which could impact unregulated hedge funds and PE funds.

FPIs and their employees are restricted from providing investment advice in publicly accessible media, directly or indirectly, without disclosure of their interest in the securities being discussed.

Because of relaxed registration norms, easing of requirements and potential expansion of investment horizon for a wider class of investors, introduction of the FPI regime is a progressive move and a part of the structural reform phase that India seems to have embarked on and could significantly aid various structural possibilities for PE investments.

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Siddharth Shah is a partner and Divaspati Singh is a senior associate at Khaitan & Co. Views of the authors are personal and should not be considered as those of the firm.