Sebi norms may have partly fuelled recent FPI sell off

Not entirely, if two fund managers and one securities lawyer are to be believed. A significant portion—ranging from one- to nearly two-fifths—of the outflows largely by global funds and global emerging market (GEM) funds can be attributed to the Securities and Exchange Board of India's (Sebi) August 2023 circular.  

The circular aims to curb potential misuse of the FPI route by Indian entities attempting to bypass Sebi's minimum public shareholding (MPS) norms. These norms mandate a minimum public float of 25% in a listed entity.

Sebi circular 

The circular, amended on 20 March 2024, required FPIs meeting specific criteria to make detailed disclosures by 9 September 2024.

This applied to FPIs holding over 50% of their Indian equity assets under management (AUM) in a single corporate group or those with equity AUM exceeding ₹25,000 crore in the Indian market, either individually or along with their investor group.

All entities holding any ownership, economic interest, or exercising control in the FPI were asked to provide details on a full look-through basis, up to the level of all natural persons, without any threshold.

Shruti Ranjan, partner at Trilegal’s corporate and financial regulatory team, mentioned that by this deadline, any non-compliant FPIs were required to liquidate their positions and exit the market, as their FPI licences would become invalid.

Market Impact

The impact of this added to the aggressive selling of large cap stocks by global funds and GEMs in the following months, after some of them met with Sebi in September, per the two managers cited earlier.

"Nobody doubts the regulatory intent to prevent round-tripping by errant entities to skirt MPS," said one of the fund managers. "But many of these FPIs or fund managers provide stock picking to global investors and invariably invest in large caps with diverse shareholding. They are the ones who chose to liquidate their holdings after meeting the regulator in September."

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FPIs net sold shares worth almost ₹1.16 trillion ($13.75 billion) during October-November. Of this, around ₹25,000-42000 crore ($3 -5 billion) was by FPIs who liquidated their holdings to avoid falling foul of the Sebi circular, according to the fund manager.

One fund manager said some of the funds awaited global index provider MSCI's rebalancing of its Emerging Markets Index on 25 November. The rebalancing was estimated to result in $2.5 billion passive inflows into India, of which $1.9 billion was slated to be into HDFC Bank alone, per Nuvama Alternative & Quantitative Research.

On 25 November, HDFC Bank, which was to receive passive flows of ₹16,032 crore, witnessed delivery worth ₹31,088 crore, as per National Stock Exchange (NSE). This was the highest delivery volume in six months. "If passive trackers of the MSCI index were to invest around ₹16,000 crores, who gave delivery of ₹31,000 crore of HDFC Bank shares that day? It was some of these GEMs and global funds who seized the opportunity to exit," he explained.

Another fund manager said the circular has been "a matter of concern for FPIs" and could be part of the reason for the FPI outflows in the past two months.

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Moin Ladha, partner at Khaitan & Co, said the selling of holdings by FPIs in the Indian markets could be "one factor" behind the increased outflows from October, but it wasn't the only reason.

A Sebi spokesperson was not immediately available to comment.

FPIs have seen their equity AUM fall from $930.36 billion as on 30 September to $823.77 billion as on 15 November, shows data from National Securities Depository Ltd (NSDL). This is partly because of the decline in share value and liquidation of a portion of their holdings.

India's Nifty has become the worst-performing benchmark among emerging market indices between 30 September and 29 November due to the relentless FII selling.

The Nifty logged a negative return of 6.5% during the period, falling from 25810.85 on 30 September to 24131.10 on 29 November. Over the same period Shanghai Composite fell just 0.3% to 3326.46, Taiwan's Taiex rose by 0.77% to 22262.5, Kospi fell 5.29% to 2455.91 and Brazil's Bovespa declined 4.66% to 125,668. These five EMs together constituted 80.01% weighting in the MSCI EM index as of October end.

While FIIs sold a net ₹1.16 trillion in the past two months, DIIs absorbed the same by buying ₹1.52 trillion of equity. However, the primary issuances through IPOs and qualified institutional placements over this period meant that supply exceeded demand due to FIIs turning net sellers, thus causing the markets to decline. For instance, two IPOs—one of Hyundai in October and Swiggy in November, led to the supply of paper worth ₹39,197 crore, neutralizing the effect of DII net purchases.

Outlook on FII

Though the structural story of India as the G-20's fastest -growing economy remains intact, the near-term sentiment of FIIs appears clouded, as the government walks a tightrope between spending and containing its fiscal deficit.

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"FPI sentiment in the near term is mixed though from a structural point of view India is among the fastest growing EMs," said Nitin Jain, CEO & CIO, Kotak Mahindra Asset Management (Singapore).

Jain did not comment on the Sebi circular but added: "Fiscal tightness of 70bps from 5.6% to 4.9% (in FY25) was expected to be offset by private capex and housing and household consumption, and that hasn't taken off the way one expected. While we expect government spending to pick up, spending is running below budgeted levels, and the fiscal deficit could be lower than the government target, which could impinge on overall demand and corporate earnings. FIIs are likely to remain reticent on Indian markets, for now."