Sebi whip on shady FIIs to affect few

Capital market regulator Securities and Exchange Board of India (Sebi)'s crackdown on shady foreign flows will impact only a minuscule part of outstanding investments under the participatory note (P-note) route.

According to an assessment done by the regulator, only about $550 million (Rs 3,400 crore) worth of P-notes are held by entities that don't qualify under the country's new Foreign Portfolio Investor (FPI) regulations. That's around 1.3 per cent of the total value of P-note investments, debt and equity, as on October 2014. According to Sebi data, the total value of investments coming through this route -typically used by entities that are not directly registered with Sebi - stood at Rs 2,65,675 crore ($43 billion).

Sebi, through a circular dated November 24, has disallowed issuance of P-notes to entities, which are not regulated in their home jurisdictions. Further, a P-note applicant has to satisfy the broad-basing criteria laid down by Sebi. To avoid opaque structures, the circular also mandates the entities to furnish the information regarding its beneficial ownership.

The circular had sparked panic among the investing community that it could lead to liquidation of existing investments and impact incremental flows.

To assuage concerns, Sebi chief U K Sinha had recently said, "We have done a complete analysis of the data, be rest assured it won't impact flows."

According to experts, the $550-million worth of P-note investments that are impacted by Sebi's circular will not be allowed to be rolled over after the expiry of the contract date.

"The circular does not affect existing ODI positions until the expiry of their ODI contracts. However, after the expiry of the ODI contracts, the positions will not be renewed/rolled-over and new positions in compliance with the circular will have to be entered into," said a note by Nishith Desai Associates.

The dependence of foreign investors on the P-note route for investing in India has gone down over the years. During 2007-08 period, almost 50 per cent of the FII flows came through the P-note route. Currently, P-notes account for only around 10 per cent of the total FII assets in the country.

"The same Sebi circular if issued in 2007 would impacted huge amount of positions. However, flows from unregulated entities over the years have reduced," observed a FPI custodian, who didn't wish to be quoted.

Minister of state for finance Jayant Sinha had also informed the Rajya Sabha on December 2 that proper monitoring was in place to keep a check on investments via P-notes and there had been huge inflow of genuine funds so far this year.

A P-note (also called offshore derivative instrument) is an instrument used investing in Indian securities without necessarily having to register with Sebi. FPIs (earlier FIIs), which are already registered and regulated by Sebi, issue these instruments to investors aboard.

Meanwhile, legal experts said the new guidelines put a lot of onus on the FPI issuers for ensuring compliance.

"Such FPIs will now have to ensure that P-note subscribers meet the same exhaustive eligibility criteria otherwise applicable to FPIs which invest directly. FPIs issuing p-notes will also have to keep a track of total investments made by subscribers…," said Rajesh Gandhi, partner, Deloitte Haskins & Sells.

According to Gandhi, the guidelines are likely to impact increment FPI investments in the country routed through the P-note route.

Appeal of this instrument, which gained popularity among overseas investors as it provided quick and easy access to the Indian market, could dim further.