Sebi allows custodians to draw up their own high-risk jurisdictions lists

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In a retreat from its earlier stance, the Securities and Exchange Board of India (Sebi) has asked the custodians to draw up their own lists of high-risk jurisdictions in lieu of a single, common list as envisaged earlier.    

In a meeting with custodians last week, the regulator told them that they could follow their own processes to identify high-risk jurisdictions, provided the list is reviewed periodically and the regulator is kept in the loop regarding the same.

This could imply that high-risk jurisdictions such as Mauritius -- a major source for FPI funds and which was included in the common list of 25 high-risk regions prepared a few weeks ago -- might now be excluded by some custodians. Other high-risk jurisdictions that were part of the earlier list include the British Virgin Islands, China, Cayman Islands, Cyprus, and the UAE.

"Sebi told the custodians that not having a common list is okay as long as all custodians prepared a list and apprised the regulator about the same," said a person in the know. A few domestic custodians, who, until this time, were believed not to possess a high-risk list, will now have to fall in line with this diktat. 

The manner of classifying a jurisdiction as high-risk or low-risk assumes significance after Sebi's circular dated April 10 on know your client (KYC) circular for foreign portfolio investors (FPIs). According to the guidelines, the threshold for identification of beneficial owners (BOs) of FPIs on controlling ownership interest is 25 per cent in case of companies and 15 per cent in case of partnership firms. For high-risk jurisdictions, the threshold is lower at 10 per cent.   

Funds investing from high-risk jurisdictions will have to comply with the KYC requirements applicable to category-III FPIs. This includes providing financial information about the fund and identity proof of ultimate BOs and authorised signatories.  

The downside with having a common list is the difference in risk perception among custodians, said experts. "What is risky to you may not be risky to me. And, there's always the possibility that a black swan event may merit a change in the risk categorisation of a particular jurisdiction. What do you do, then?" said another person, on the condition of anonymity.

The earlier high-risk list had led to unease among custodians, especially the foreign ones, which typically adhere to a globally mandated process to identify these regions. The problem was compounded by Sebi's reluctance to come out with an official guidance or circular on the matter. It had even told the Financial Services Commission (FSC) of Mauritius that it was not working on a list that would identify Mauritius as a high-risk jurisdiction.

Drawing up individual lists, however, could lead FPIs to move business from one custodian to the other depending on the presence or absence of a particular region on the custodian's list, said experts.

For instance, custodians that classify Mauritius as high-risk could see business migrate to rival custodians. "Different lists can lead to regulatory arbitrage, which is one of the reasons why Sebi wanted a common list in the first place," said the second person quoted above.

Currently, FPIs are subject to a KYC review as and when there is any change in material information or disclosure. Going forward, a comprehensive KYC review of FPIs will be done periodically.

For instance, for high-risk clients, the KYC check will be done yearly; for others, it would be once every three years. Sebi is also reportedly mulling greater scrutiny for high-risk jurisdictions that could include six-monthly KYC and monthly or three-monthly reporting of beneficial ownership.