Sebi plans to tag Chinese participation through FPI route

Sebi’s proposal moves means greater scrutiny of China and Hong Kong-based investors who take Singapore or Mauritius route to enter India.

Foreign portfolio investors (FPIs) with China links are set to face enhanced scrutiny from the market regulator the Securities and Exchange Board of India (Sebi).

On July 30, Sebi floated a consultation paper that essentially proposes to divide FPIs into two categories — where the majority ownership is by investors from Land Bordering Countries (LBCs) and those in which more than 50 percent is owned by what the paper refers to non-LBCs.

The move will mean greater monitoring of China and Hong Kong-based investors who frequently use Singapore and Mauritius structures to enter India through the FPI route.

Many leading global investment managers are said to have created Singapore or Mauritius-based FPI vehicles for the Chinese to invest in India.

Since these funds come from neutral jurisdictions such as Singapore, they often conceal the Chinese connection of the fund, FPI experts say.

Sebi has also proposed a key tweak to procedures adopted by custodians and depositories to ensure that FPIs comply with this rule.

Currently, most of the FPI compliance documentation is based on declarations given by the funds to custodians regarding their beneficial owners.

Sebi now wants depository participants to verify the filings made by FPIs with regards to China links and attest if the filings are correct, say market experts.

Tighter monitoring

There are no investment restrictions on Chinese investors coming into India via the FPI route. Being labelled as LBC FPI would only put the fund on a special monitoring list.

The intention behind this enhanced surveillance is to ensure there is no regulatory arbitrage available for Chinese investors. They require prior government approval to make a Foreign Direct Investment (FDI) in unlisted companies in India.

The proposals are intended to ensure China-based investors don’t use the FPI regime to circumvent the FDI restrictions, the consultation paper said. Sebi didn’t elaborate on how such a potential misuse could take place.

“The consultation paper proposals are a step in the right direction. There is no need to file and track granular details of UBOs if the LBC investors own less than 33 percent. DDPs are rightly given power to determine in other cases whether LBC investors control the FPIs and deal with them appropriately. This will create a better mechanism to regulate investments from LBC investors through the FPI route,” said Punit Shah, partner, Dhruva Advisors.

UBO is short for ultimate beneficial owner and DDPs are designated depository participants.

Sebi had originally floated the discussion paper in August 2023 to enhance disclosure norms for FPIs which hold a large part of their portfolio in only a few companies. The rules were brought in following the Adani-Hindenburg saga.

Certain FPIs who meet the conditions specified need to disclose granular details of their beneficial owners. Sebi made a generic reference to the potential misuse of the FPI route by LBC investors in the August paper. Sebi, however, didn’t provide any details regarding the purpose for which such granular data of beneficial ownership is required.

In the July 30 consultation paper, the market regulator explained the rationale, saying it is intended to label FPIs as LBC and non-LBC along with curbing circumvention of minimum public shareholding (MPS) rules.

Experts say since Sebi has now adopted the approach of determining ownership based on the nationality of the end investors and not where the fund is based, Hong Kong-based FPIs whose beneficial owners are from countries such as the US and the UK should be exempt from the LBC tag.

“There may be instances where an FPI is a Hong Kong entity, but its beneficial owners (BOs) are not Chinese or Hong Kong investors. In such cases, the same disclosure requirements should not be imposed on these Hong Kong FPIs, consistent with the principle of focusing on the nationality of the beneficial owners,” said Suresh Swamy, Partner, Price Waterhouse & Co LLP.

Eases compliance burden

The paper, however, eases the compliance burden on several FPIs, say experts. According to the discussion paper, if an FPI has more than 67 percent non-LBC ownership, such funds needn’t provide granular details of the beneficial owners.

If a fund is more than 50 percent owned by LBCs, such fund will be straight away labelled LBC FPI and needn’t provide any further beneficial ownership data either.

“This step to introduce objective thresholds for identifying the FPIs with LBC links will reduce the burden of FPIs from other territories. It will also enable SEBI to effectively monitor the FPIs as the quantum of reporting will also be reduced. The proposal would go a long way in improving ease of business for the funds,” said Sidharth S Kumar, Senior Associate, BTG Advaya.