Monitoring system for foreign portfolio investors to undergo HDFC Bank test

The new system for monitoring the limits on investment flows from abroad will undergo their first big test on Monday. That is when shares worth Rs 92 billion ($1.38 billion) in HDFC Bank will open for foreign portfolio investor (FPI) buying. 

According to information on the websites of  National Securities Depository (NSDL) and Central Depository Services (CDSL), both responsible for monitoring of FPI shareholding in listed firms, room has been created to buy 43.6 million shares (1.68 per cent stake) in the country’s highest valued bank has been created.

Fresh FPI buying in the bank is being permitted for the first time since February 2017. Being the most sought stock for FPIs, analysts expect a scramble by global funds to buy shares of the lender on Monday. 

The trigger for the new FPI monitoring framework was HDFC Bank itself. In 2017, when FPI buying was permitted in the counter, demand surpassed supply by such a huge margin that the Reserve Bank of India had to issue a circular midway, banning purchase. Still, the 74 per cent FPI shareholding limit in HDFC Bank was breached, posing a headache for regulators as to how to rectify the situation. While all the trades had to be honoured, it prompted a rule change to avoid a similar problem in future.

Under the new rules, in a similar breach, FPIs which bought new shares need to divest their holdings within five days. This system was notified in April by the markets regulator, Securities and Exchange Board of India (Sebi), in consultation with RBI. These became operational on May 1. 

On Friday, for the first time, both NSDL and CDSL put out a so-called ‘red flag’ list of companies where the aggregate FPI investment limit had dropped below the permissible cap. Beside HDFC Bank, IndusInd Bank (2.1 per cent room available) and Sunteck Realty (1.25 per cent) are among the other stocks where new FPI buying will be permitted. 

Companies under the red-flag list are those where the available headroom is less than three per cent. New FPI buying is permitted in these but with a caveat that foreign investors will divest their excess holdings within five trading days from the day of breach. The divestment will have to take place on a proportionate basis. For instance, 43.6 million shares of HDFC Bank are available for FPI purchase but assume that they buy 87.2 million shares. As this is twice the actual available ones, all the FPIs which purchased under the new buying window will have to divest half of their shares in the next five trading sessions. Therefore, someone who bought 100 shares will have to divest 50.

Experts say FPIs will need to tread with caution. “As demonstrated last time, FPIs are willing to buy a hefty premium to buy HDFC Bank shares. However, this time, if there is huge demand, they might end up making losses, as they will buy at a premium and will be forced to sell at the market rate,” said a senior official with a custodian.

Something similar took place in April 2017, when shares of HDFC Bank had climbed as much as 10 per cent but gave up most of the gain to close only 3.7 per cent higher after RBI banned fresh buying.

This time, RBI or Sebi won’t halt fresh buying midway; the FPIs themselves will have to keep a tab on the demand situation, as they will eventually have to divest.

The new circular says if FPIs fail to disinvest as required, ‘necessary action’ shall be taken by Sebi against such funds.

“With necessary infrastructure and new systems, monitoring of foreign investment limits in listed Indian companies is expected to be more efficient,” says consultancy PwC.