Need more disclosures from foreign portfolio investors

(MainsGS2:Indian Economy and issues relating to planning, mobilization, of resources, growth, development and employment.)

Context:

The Securities and Exchange Board of India (SEBI) floated a consultation paper that proposed additional disclosures from Foreign Portfolio Investors (FPIs).

Additional disclosures:

High-risk FPIs holding more than 50% of their equity asset under management (AUM) in a single corporate group would have to make additional disclosures.
However, new FPIs that have just begun investments would be allowed to breach the threshold criteria up to a period of six months, following which, they too would have to make the disclosures.
Further, existing ones in the process of winding down their investments in a single corporate group would be temporarily allowed to breach the criteria.
Other than this, the paper also proposes that existing high-risk FPIs with an overall holding in the Indian equity market of over Rs 25,000 crore comply with the disclosure mandate within six months.
Failing this, they would have to bring down their holding within the threshold. High-risk FPIs expecting to breach the threshold in future would only have three months to comply.

Enhancing trust:

As per the SEBI, the objective is to “enhance trust in the Indian securities markets by mandating additional granular disclosures around ownership of, economic interest in, and control of objectively identified high-risk FPIs” that have either concentrated exposures to a single group and/or significant holdings by means of equity investments in India.
As per observations in the report, the regulator’s own investigation was made tougher by a change in the legislative policy under the FPI Regulations, 2014.
Based on the recommendation of a Working Group, in 2018, the provision dealing with ‘opaque’ structure and disclosing “every ultimate natural person at the end of the chain of every owner of economic interest in the FPI” was done away with.

Curtail incidences of multiple routes:

The proposed regulations would thus try and identify tangible ownership and curtail incidences of multiple routes being used to acquire ownership in a company.
This would help avert regulatory requirements, and more importantly, keep up with the minimum public shareholding norms.
For perspective, it requires that public shareholding, or the shares held by the public for a listed entity, must be at least 25% to continue being listed.
The markets regulator acknowledges that on the surface, any enhanced disclosure requirements may appear to detract from ease-of-doing investments, adding, “However, there can be no sustained capital formation without transparency and trust.”

Concentrated investments:

The broad issues that prompted floating of the proposed regulation in the consultation paper are: potential misuse of the FPI route and concentrated group investments by foreign portfolio investors endeavoring to bypass regulatory requirements (such as that for minimum public shareholding).
It has been observed that FPIs direct a substantial portion of their equity portfolio in the country to a single investee company or a company group.
In some instances, the investments (as against the regular buying and selling in a market) have been observed to be static and maintained for a long time.
SEBI observes, “Such concentrated investments raise the concern and possibility that promoters of such corporate groups, or other investors acting in concert, could be using the FPI route for circumventing regulatory requirements such as that of maintaining minimum public shareholding.”
This would entail that the suggested free float, or the shares available in the open market for public trading without restrictions, , may not actually be correct and the practice may also invite price manipulation in such scripts.

Potential circumvention:

The regulator’s other concern is about the potential circumvention. The central government amended the FDI policy that required an entity sharing a land border with India, or where the beneficial owner is based out of any such country, to do so only via the government route.
It may happen the FPI entity is located in a country with which India does not share a land border, but the investor in the FPI (or the beneficial owner of the FPI) might be a citizen and/or residing in such a country.
The proposed regulations in such cases would be able to trace such ownership and economic interest, courtesy the additional disclosures

Proposed disclosures:

The proposed regulations would enhance transparency, fully identifying objective ownership of an entity in a holding – by examining control through direct and indirect exposure alongside a clear illustration of economic interests in the holding.
It forms the basis of the look-down approach, to the level of natural persons, public retail funds or large listed corporations (that form part of the ownership structure).
The assessment would be over and above the materiality threshold that is used to determine beneficial owners as per relevant laws.
All in all, the proposed legislation would try and examine your overall exposure, structured by determining direct and indirect exposures to establish your hold and overall holding in the company.
This must not violate the provisions of the minimum public shareholding requirements.

Risk scenario:

The proposed legislation categorises FPIs into low risk, moderate risk and high risk.
Low risk would cover government and government-related entities such as central banks or sovereign wealth funds where the facts about ownership, economic and control interest can be deciphered from the government ownership.
Moderate risk refers to pension funds or public retail funds with widespread and dispersed investors.
They would be categorised only if designated depository participants can independently validate and confirm the status of such FPIs as pension funds and public retail funds with a wide and diverse investor base.