A Securities and Exchange Board of India (Sebi) working group has proposed simpler rules for foreign portfolio investors (FPIs) that will increase direct investment by them in Indian equities and reduce investments through opaque channels such as participatory notes (P-notes).
The changes include reducing documentation and minimizing compliance requirements for a certain class of investors such as sovereign wealth funds and pension funds, according to three people familiar with the development, including a Sebi official.
FPIs held ₹ 2.4 trillion worth of Indian assets at the end of June. P-notes accounted for 8.8% of these holdings. These are instruments issued by registered foreign institutional investors (FII) to overseas investors who wish to invest in Indian equities without registering themselves with Sebi.
The working group has suggested that category-I FPIs be given preferential treatment in know your customer (KYC) compliance if they belong to a jurisdiction that is part of the Financial Action Task Force (FATF), an inter-governmental body that drafts policies to combat money laundering and financing of terrorist groups.
Currently, this is allowed only for those entities who come from a country that is part of the International Organization of Securities Commissions or Bank for International Settlements (BIS).
Category-I FPIs typically include foreign central banks, sovereign wealth funds and government agencies.
There are many banks that come from well-regulated jurisdictions but are not members of BIS and thus cannot directly invest in India. The working group has recommended that such banks be given preferential treatment to meet compliance norms.
A Sebi spokesperson did not respond to an email seeking comment.
The panel has also suggested relaxing the definition of broad-based funds. Currently, Sebi rules mandate that a fund should have at least 20 investors to qualify as broad-based, a pre-requisite for a Category II licence.
Category II FPIs include banks, asset management companies and investment managers.
“A new fund may not have 20 investors from Day 1. The working group has recommended some relaxations on this criterion," said one of the three people familiar with the matter. None of the three wanted to be identified.
“It is challenging for global proprietary trading desks to qualify as broad-based funds. Some of these desks are regulated in their home country. But due to the broad-based condition requirement, their ability to obtain Category II FPI licence is limited. They get pushed to Category III, which is a concern," said Suresh Swamy, partner, financial services, at PricewaterhouseCoopers, a consultancy firm.
Category III FPIs are typically hedge funds. This class of investors has onerous compliance requirements.
The working group’s third recommendation is to allow FPIs to invest in Indian debt on-tap. Currently, FPIs have to participate in an auction process once investment limits (set by RBI) have been breached. This leads to higher prices for FPIs and deters investment in debt.
“There are recommendations to allow debt allocation on an on-tap system and ease reporting/settlement requirements applicable to FPIs," said the second person, who is consulting with the working group.
This is the second time in three years that the market regulator is easing norms for overseas investors.
In October 2013, Sebi introduced new regulations with easier registration process and operating framework for foreign investors. For instance, it allowed them to register with custodians instead of directly with Sebi.
That simplified the lives of FPIs, as the norms were onerous as compared with those in developed economies. The working group’s recommendations are aimed at simplifying norms further.
“The working group has been in consultation with the market participants and Sebi on the issues that are faced by FPIs while investing in India. These recommendations will be tabled in front of the Sebi board for implementation," said the Sebi official, the third person cited earlier.
The “central government and Sebi have been proactive, be it on the taxes and levies or the registration timelines (for FPIs), though recent SIT (Special Investigative Team on black money) recommendations on tightening KYC requirements have increased Sebi’s challenges," said Sumit Agrawal, ex-Sebi official and partner, Suvan Law Advisors, a law firm specializing in regulatory matters. Simpler norms would reduce the administrative and compliance costs of FPIs, he added.
Sebi had been simultaneously tightening regulations on P-notes. “There are large number of fund managers wanting to invest in India directly. Due to the difficulties faced in registration, they opt for the P-Note route. For instance, FPIs are now being advised to have a PAN (Permanent Account Number issued by India’s tax department) in place," Swamy of PricewaterhouseCoopers said.
Sebi’s aim is to “see more funds (come in) through FPI route", added the Sebi official.