Sebi's separate FPI registration plan draws flak from investors

The Securities and Exchange Board of India’s (Sebi’s) recommendations to make it mandatory for sub-funds with segregated portfolios to take separate FPI registrations have invited strong opposition from foreign portfolio investors (FPIs). They fear such a move could compel them to liquidate their holdings, incur huge costs, and potentially disrupt the Indian stock market.

Scores of FPIs who invest for their clients have different sub-funds or share class, each with a different strategy. For example, about 270 Société d'investissement à Capital Variable (SICAV) funds — open-ended collective investment funds domiciled in European jurisdictions like Luxembourg and France — operate with such structures and invest millions of dollars in the country. A number of such funds could get impacted.

The regulator had formed a committee under the chairmanship of Reserve Bank of India deputy governor H R Khan to review existing FPI regulations. The committee submitted its proposals to Sebi on May 24, and the regulator invited public comments till June 14.

At present, a number of such FPIs have a common permanent account number (PAN) and FPI registration certificate. According to the proposals, sub-funds will need to register separately as FPIs and get a separate PAN, and consequently, a different demat account.  

Each FPI will have to transfer existing assets from its demat account to that of each of its sub-fund. To do this, the FPI will have to first sell its assets in the market, after which sub-funds will have to buy these back. This is because FPIs cannot make free of payment transfer of securities, according to existing norms. Direct transfer of shares between FPIs and their sub-funds will invite tax in the hands of the recipient to the tune of 30-40 per cent.

“Existing FPIs will be forced to liquidate their Indian portfolio and sub-funds seeking separate registration as FPIs will have to buy those securities over the market. This will entail huge transaction costs for all parties concerned, including sub-funds,” said a person familiar with the matter.

The transfers to the new accounts will have to be done through block deals, which could be messy and potentially disrupt Indian markets, considering the sheer volume of share transactions that may be effected, said experts. Sub-funds may have to get additional funds from overseas to buy back the shares.

“When you buy back the shares, you will have to send money to India, which could remain in the system for a day or two. As a result, sub-funds will need to manage the foreign exchange risk,” said Girish Vanvari, founder, Transaction Square.

What’s more, Mauritius and Singapore investors who had purchased shares before April 1, 2017, may lose out on the grandfathering benefits, especially since share prices have significantly corrected in many cases, added Vanvari.

A number of investors have written to the regulator to apply the proposals, if at all, only to the new funds or investments, and not existing ones. Alternatively, they want the regulator to permit free of payment transfers of securities from existing FPIs representing multiple sub-funds to each of the sub-funds or share class seeking separate registrations as FPIs. At present, Sebi permits off-market transfer of Indian securities on a free of payment basis only where there is no change in beneficial ownership, before and after the transfer.

Existing FPIs will be provided one year to comply with the new registration requirements. However, the time limit of one year has not been incorporated in the proposed amendment to Regulation 5(b) of the Sebi (FPI) Regulations, 2014. This anomaly will have to be set right as well.

To be sure, the primary objective of the committee’s proposal was to ensure sub-funds with distinct portfolios do not get to set off losses against each other. This is possible under the existing regime since sub-funds are considered one entity under a single FPI. Having separate accounts will also help in determining the assets and liabilities of each sub-fund.  

“There were concerns raised on taxation of such entities where entity X investing in India on behalf of its two sub-funds A and B with separate investors and segregated portfolio may set off profit of sub-fund A, against the loss of sub-fund B, thereby lowering the tax liability of X. From a regulatory perspective also, there is no justification in giving the same registration to these sub-funds when they invest independently,” the committee had observed in its recommendations.