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Why Sebi's new KYC norm may lead to the exit of many legitimate investors

Topics Sebi

There are also serious privacy concerns given the information demanded in the KYC
A SEBI circular will cause a lot of market turmoil unless it is reviewed and reworded. On April 10, SEBI modified the KYC norms applicable to Foreign Portfolio Investors. NRIs, OIC s and PIOs are now prevented from being "Beneficial Owners", or "in control", via the FPI route.

This was done with the intent of preventing money-laundering and round-tripping, maybe with an eye to reduce hawala funding before the General Elections of 2019.  Hence, FPIs are being told to disclose Beneficial Owners (BO). The threshold is set at 25 per cent for controlling ownership for companies, and 15 per cent for partnerships.  The threshold is lower, at 10 per cent, for "high-risk" nations with a history of money-laundering and terrorism, etc. 

Any single FPI can hold a shareholding limited to 10 per cent in a given Indian listed company.  If the limit is breached, the BO must either opt to be treated as a Foreign Direct Investor, or sell stakes to reduce shareholding below 10 per cent, within five trading sessions of the breach of limit. The order comes into effect by December. 

While the intent may be laudable, there are several problems with the approach. FPIs' ownership of Indian equity amounted to about $425 billion on Aug 15, 2018.  Out of this, NRIs have invested an estimated $75 billion, via funds where majority shareholders and managers are FPIs. The order implies they are all potential criminals. It may trigger wholesale selling since NRIs cannot operate through the FPI route anymore. 

Another big problem is the definition of a "BO" in the Prevention of Money Laundering Act (PMLA). A BO is "a natural person, or persons who, whether acting alone or acting together, have controlling ownership interest in the FPI or control over the FPI." If a BO cannot be directly identified, the senior managing official of the FPI, is assumed to be the BO. 

The word ‘control’ is also defined very broadly in PMLA. It includes the right to appoint a majority of directors, or control management or policy decisions, by virtue of shareholding, management rights, shareholders' agreements and/or voting agreements.  

Given the definitions,  many FPIs would end up with a single officer defined as "BO". In Japanese structures for instance, one person may handle thousands of accounts. This means that the 10 per cent shareholding ownership limits would be clubbed together and apply to that single BO. In that case, if many entities hold positions that, taken together, exceed 10 per cent, the FPI will be forced to divest. 

Apart from the Japanese, many global asset management companies like Fidelity, BlackRock, Franklin Templeton, Goldman, etc., run multiple India-focussed funds. A single officer may be considered the BO for all funds from one house. If that's so, the separate funds may be forced to sell, even if those funds are all individually below the 10 per cent limit.

There are also serious privacy concerns given the information demanded in the KYC.  This includes address, date of birth, tax residency number, social security number, and passport number, etc., of the BO. This is far more than global disclosure norms, and many FPIs will be uncomfortable about sharing so much information with a country, which doesn't yet have data protection or privacy laws. 

Sebi must think hard about how these definitions should be reworded. Otherwise, this order will lead to the exit of many legitimate investors when it comes into effect in December. 

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