The Securities and Exchange Board of India (SEBI) has mandated additional disclosures from foreign portfolio investors (FPIs) to enhance transparency. This requirement particularly targets FPIs with concentrated holdings in a single group which is in response to the Adani-Hindenburg episode. The regulator aims to address systemic issues and has released a proposal to identify the ultimate beneficial ownership of offshore funds.
The tighter SEBI norms are outcomes of the fear that FPI inflows are used to conceal ownership of Indian shares by certain entities. While several stakeholders have welcomed the SEBI move to increase transparency and reduce the chances of price manipulation, it is expected to dampen portfolio flows and force FPIs to revise their India strategy.
What is SEBI’s proposal on FPIs?
FPIs consist of securities and other financial assets held by investors in another country. Although they do not provide direct ownership of a company’s assets, their liquidity depends on market volatility.
Last week, SEBI proposed categorizing FPIs with a composite exposure of over Rs 25,000 crore and a single-group exposure of over 50% of their assets as high risk. This categorization would require high-risk FPIs to provide additional disclosures, including full identification of their ownership, economic interests, and control rights down to the level of natural persons or public retail funds or large listed companies.
Among SEBI’s major proposals, it stated that these new rules will override the secrecy laws of other jurisdictions. Implementing such rules in defiance of secrecy laws in other jurisdictions presents challenges, but the responsibility for disclosure primarily lies with designated depository participants (DDPs) who facilitate FPI registration and investments.
Previously, Hindenburg Research, a New York-based activist investor group, accused the Adani Group of engaging in accounting fraud and a stock manipulation scheme for decades, leading to a sudden plummet in Adani Group’s stock prices. The report alleges that the Adani Group artificially inflated stock prices by creating a sense of scarcity to boost demand and, consequently, prices.
Hindenburg claims that the stocks that should be held by the public are actually offshore funds tied to Adani. According to SEBI rules, promoters cannot own more than 75% of stocks, and the report suggests that the Adani Group concealed ownership and possesses more than what is visible. In the Adani-Hindenburg saga, the regulator faced difficulties in identifying the ultimate beneficiaries of certain FPIs. However, none of the allegations have been proven, and the group has strongly refuted them.
Apart from the criticism SEBI faced following the Adani Group fiasco, there is another reason why the regulator chose to impose stricter rules for FPIs. The Financial Action Task Force (FATF), a global body combating money laundering, is set to review India in November this year, and any adverse comments by FATF can impact FPI inflows.
Currently, SEBI estimates that Rs 2.6 trillion, or 6% of FPI assets under custody (AUC), are at risk of being classified as high risk. However, the regulator has yet to finalize the proposal, which will also be floated for market feedback. FPIs are expected to adopt a wait-and-watch approach. The regulator stated that a six-month grace period will be provided for FPIs to comply. Failure to do so could result in the revocation of their licenses.
Previously, SEBI made significant changes to its FPI regulations in 2018, resulting in undisclosed ultimate beneficiaries by foreign investors. At least one large corporate house was found guilty of round-tripping through the stock market and using related entities in offshore tax havens to manipulate stock prices in domestic markets.
The downside of SEBI’s proposal is that analysts believe it may make investors jittery and apprehensive about the disclosed information regarding their structures, especially when funds are deployed across different jurisdictions. FPIs falling under the high-risk category will reassess their investors and the flow of funds to comply with the disclosure requirements. However, there is also a possibility that they may consider exiting or reducing their high-risk status. To achieve this, FPIs can restructure their holdings by divesting their Indian holdings and relocating them to more favourable jurisdictions.
Furthermore, one cannot overlook the legal and contractual challenges in overseas jurisdictions when determining ultimate beneficial ownership. This is particularly true for countries where the applicability of SEBI’s proposed amendments is domiciled and where omnibus structures are allowed.
The data on portfolio investments, however, seem to validate the Sebi stance. Tighter disclosure norms for foreign portfolio investors announced by the market regulator after the Adani-Hindenburg episode do not seem to deter these institutions from investing in India. FPIs pumped in Rs 11,631 crore in April, Rs 43,838 crore in May, and Rs 6,489 crore in the first two days of the current month. India’s strong growth and healthy fundamentals can be attributed to the hunger for Indian stocks.