Disruptive norms

The Securities and Exchange Board of India’s (Sebi’s) revised know-your-customer norms for foreign portfolio investors (FPIs) could trigger a wave of selling in mid-October, when the changes come into effect. At the heart of the circular is the mandate that non-resident Indians, overseas citizen of India and persons of Indian origin cannot be beneficial owners (BOs) of FPIs. The threshold for identifying beneficial owners of FPIs on controlling ownership interest is 25 per cent in case of companies and 15 per cent for partnership firms. The threshold has been set lower, at 10 per cent, for "high-risk" nations with a history of money-laundering and terrorism. FPI investments are capped at a limit of 10 per cent for the equity of a single company. If the limit is breached, the BOs must either be treated as a foreign direct investor or sell in order to bring shareholding below the 10 per cent limit within five trading sessions of the breach. 

The circular raises several concerns. For one, the definition of a BO in the Prevention of Money Laundering Act 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 identified in this manner, a senior managing official of the FPI is construed to be its BO. Moreover, the word “control” is also defined vaguely in the Prevention of Money Laundering Act; 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. Taking these definitions together and given the organisational structure of most FPIs, many of them would end up with a single officer defined as the BO for Sebi's purposes. 

But in a Japanese FPI, for instance, one person may be handling thousands of accounts. The ownership limits would then be clubbed and applied to that single individual. In that case, if two entities hold positions that, taken together, exceed the 10 per cent limit, the FPI may be forced to divest. This will have a direct bearing on the functioning of global asset management companies such as Fidelity, BlackRock, Franklin Templeton and Goldman that run multiple funds in India. In addition to this issue, which could trigger selling, there are also concerns about privacy. The KYC form demands disclosure of intimate information such as address, date of birth, tax residency number, social security number and passport number, among others. Global privacy norms make FPIs uncomfortable with regard to sharing this level of information.

It would be advisable for Sebi to review this order. It is unusual for any regime anywhere to demand this level of differentiated information for KYC. There will also be practical difficulties in imposing the limit unless the definition of a BO is redefined pragmatically, or the limit removed. The intent of the circular — avoiding money laundering or round-tripping of hawala funds — is clear enough, but there must be less disruptive ways to do that without forcing legitimate investors to exit.



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