Beneficial ownership: Why Sebi's new KYC norm upsets NRIs, global investors

Illustration by Binay Sinha
The Securities and Exchange Board of India’s (Sebi’s) know your client (KYC) circular for foreign portfolio investors (FPIs) issued on April 10 has sent non-resident Indians as well as custodians and global investors in a tizzy over the way it has been worded. 

Experts suggest that there is little precedence of such restrictions in other countries. While the ostensible aim is to prevent money laundering and round-tripping of funds, there are murmurs that the true objective is to cut off overseas funding to political parties in the run-up to the national elections next year, especially from jurisdictions like Mauritius. 

“Globally, there is increasing focus of securities regulators in identifying ultimate beneficial ownership and unearthing the layers. Sebi's circular requires clarity on the criterion or threshold of beneficial ownership to streamline existing structures and boost foreign investment," said Sumit Agrawal, founder, RegStreet Law Advisors and ex-Sebi official.

At the heart of the circular is the mandate that non-resident Indians (or NRIs), along with PIOs/OCIs, cannot be beneficial owners (BOs) of FPIs. The threshold for identification of beneficial owners 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.

“Several FPI managers are restructuring their offshore operations to eliminate Indian resident ownership and control but there was no need for such a requirement as such structures were set-up with the approval of Indian regulators,” said Tejesh Chitlangi, senior partner, IC Universal Legal.

High-risk countries include those known for terrorism and fraud, where the existence of money laundering controls is suspect and banking secrecy or corruption is high. Sebi has now asked the custodians to follow their own processes to identify high-risk jurisdictions and review it periodically.

The definition of BO has to be interpreted together with the criterion provided in Rule 9 of the PMLA Rules whereby a BO would be 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 identified in this manner, the senior managing official (SMO) of the FPI would be construed to be its BO.  

According to Deloitte, the word ‘control’ is defined broadly in PMLA rules to include the right to appoint a majority of the directors or to control the management or policy decisions, including by virtue of their shareholding or management rights, or shareholders agreements or voting agreements. 

“Considering the broad definition, would persons who have majority ownership or control over the sponsor or investment manager which controls the FPI through management shares or otherwise be considered to be the BO of the FPI?” asks a Deloitte report on the subject. 

Market watchers are now hoping that Sebi tweaks the regulations to differentiate between the NRIs and PIOs/OCIs, excluding the latter from the restrictions of the April circular. This will not be easy, however, because of the all-encompassing definition of NRIs.

PIOs are foreign citizens, who at one point of time held an Indian passport, or whose parents, grandparents or great-grandparents were born and were permanent residents in India, or who is a spouse of a citizen of India or a PIO.

An OCI is a foreign national who was a citizen of India on or after January 26, 1950. NRIs are Indian citizens who stay abroad for employment or for business purposes or any other purpose, indicating an indefinite period of stay abroad.

“Sebi may re-look at some of the restrictions from a practical perspective. It's true that NRIs can invest in India directly via mutual funds or AIFs, but it may not be prudent to restrict their investments through otherwise legitimate FPI vehicles as long as KYC compliances are in place,” Chitlangi said.

The other worry is that clubbing the investment limit for FPIs based on the identity of BOs may jeopardise billions of dollars coming into India from offshore funds. Global asset managers such as Fidelity, BlackRock, and Franklin Templeton run multiple offshore funds that put their money into Indian equities. All of these funds are likely to identify single BOs or SMOs as BOs across funds. 

For instance, if one of Fidelity’s funds buys 4 per cent in TCS and another buys 7 per cent, the individual funds remain well within their limits, but Sebi’s 10 per cent cap will get breached once these investments are clubbed.

What compounds the matter further is that most of these funds operate independently and do not share information about the percentage or amount of investment in stocks. Funds that operate through common trustees could also see their investments get clubbed by virtue of having a common BO in the form of a trustee.

Custodians of FPIs, as well as industry lobby groups, have now written to the regulator raising privacy concerns arising out of the circular. FPIs have to disclose BOs’ details such as address, date of birth, tax residency number, social security number and passport number. Investment firms globally are not comfortable with sharing personal information of their employees and no one is quite sure if India has the right infrastructure in place to ensure adequate security.

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