Update on the Securities and Exchange Board of India (Foreign Portfolio Investors) Regulations, 2019 and Operational Guidelines

The Securities and Exchange Board of India (“SEBI”) has on September 23, 2019 notified the (Foreign Portfolio Investors) Regulations, 2019 (“2019 FPI Regulations”), which has repealed SEBI (Foreign Portfolio Investors) Regulations, 2014 (“2014 FPI Regulations”).  To facilitate implementation of the 2019 FPI Regulations and to ensure efficient transition from the 2014 FPI Regulations, SEBI has on November 5, 2019 issued a consolidated operational guidelines (“Operational Guidelines”) foreign portfolio investors (“FPI”) which, inter alia, consolidates and replaces all existing circulars, frequently asked questions, operating guidelines, other guidance issued by the FPI division of SEBI from time to time. With respect to the directions or other guidance issued by SEBI, as specifically applicable to FPIs, shall continue to remain in force.

AZB & Partners has been a part of the Working Group constituted by SEBI under the Chairmanship of Harun R. Khan (Retd. Deputy Governor of Reserve Bank of India) for reviewing and recommending changes to the 2014 FPI Regulations, many of which recommendations have been incorporated in the 2019 FPI Regulations and/or the Operational Guidelines. Set out below is an overview of the key aspects and/or changes captured under the 2019 FPI Regulations and the Operational Guidelines :

Sr. No.HeadingText
1.Number of categories of FPIs

Unlike the 2014 FPI Regulations, under the 2019 FPI Regulations there are only two (2) categories of FPIs, i.e. Category I FPI and Category II FPI.

2Re-categorisation of existing FPI

All existing Category I FPIs are deemed to have been registered as Category I FPIs under the 2019 FPI Regulations.

All existing Category III FPIs are deemed to have been registered as Category II FPIs under the 2019 FPI Regulations.

All existing Category II FPIs are deemed to have been registered either as Category I FPI or Category II FPI under the 2019 FPI Regulations, depending on the eligibility criteria met by such FPIs under the 2019 FPI Regulations. For eg. pension funds and university funds registered as Category II FPI under Regulation 5(b)(iv) of the 2014 FPI Regulations are now deemed to be registered as Category I FPI under Regulation 5(a)(ii) of the 2019 FPI Regulations, etc.

There will be no deemed re-categorization for existing Category III FPI registration to Category I FPI under the 2019 FPI Regulations.

All regulated / unregulated entities from non FATF member countries would not be characterized as Category I FPI, but would be moved to Category II FPI under the 2019 FPI Regulations. FPIs desirous to be re-categorized from Category II FPI to Category I will have to request its designated depository participant (“DDP”) along with requisite information, documents and payment of applicable fees.

No incremental fees is required to be paid by existing FPIs upon such deemed recategorization.

Existing FPIs are not required to take any steps in relation to the above deemed re-categorization of registration, which shall be implemented by National Securities Depository Limited in consultation with the respective DDPs of the FPIs. All existing FPIs as on September 23, 2019 should have received emails from their DDPs informing them of the said re-categorization and the Category under which the FPI is now deemed to be registered under the 2019 FPI Regulations.

Existing FPIs which are required to provide any incremental KYC documents to their DDP due to re-categorization have been provided 90 days to comply with such requirements.

3.New Categories of FPIs

The 2019 FPI Regulations provides for only two categories of registrations for FPIs, i.e. Category I FPI and Category II FPI.

(a)   “Category I foreign portfolio investor” registration can be obtained by–

(i)   Government and Government related investors such as central banks, sovereign wealth funds, international or multilateral organizations or agencies including entities controlled or at least 75% directly or indirectly owned by such Government and Government related investor(s).

(ii)  Pension funds and university funds (Pension funds shall include superannuation or similar schemes that provides retirement benefits to employees/ contributors.).

(iii)  Appropriately regulated entities such as insurance or reinsurance entities, banks, asset management companies, investment managers, investment advisors, portfolio managers, broker dealers and swap dealers.

(iv)    Entities from the Financial Action Task Force (“FATF”) member countries which are –

I.        appropriately regulated funds.

II.     unregulated funds whose investment manager is appropriately regulated and registered as a Category I foreign portfolio investor.

Provided that the investment manager undertakes the responsibility of all the acts of commission or omission of such unregulated fund.

III.    university related endowments of such universities that have been in existence for more than five years.

Please note that currently there are 37 countries and 2 regional organisations (the Gulf Cooperation Council and the European Commission) which are FATF member jurisdictions.

Further, SEBI has in the Operational Guidelines clarified that an entity ‘from a FATF member country’ shall mean that the entity has its primary place of business in a FATF member country and, if regulated, is appropriately regulated in a FATF member country.

v. (i) An entity (A) whose investment manager is from the FATF member country and such an investment manager is registered as a Category I FPI; or (B) which is at least seventy-five per cent owned, directly or indirectly by another entity, eligible under sub-clause (ii), (iii) and (iv) of Regulation 5(a) of the 2019 FPI Regulation and such an eligible entity is from a FATF member country.

Provided that such an investment manager or eligible entity undertakes the responsibility of all the acts of commission or omission of the applicants seeking registration under this sub-clause.

(b)   “Category II foreign portfolio investor” shall include all the investors not eligible under Category I FPI such as – appropriately regulated funds not eligible as Category-I FPI, endowments and foundations, charitable organisations, corporate bodies, family offices, Individuals, appropriately regulated entities investing on behalf of their client (as per conditions specified by SEBI from time to time), and unregulated funds in the form of limited partnership and trusts.

4.Requirement to meet broad based fund criteria, submit PCC/MCV declaration done away with

Certain categories of FPIs under the 2014 FPI Regulations were required to meet broad based fund criteria, and were correspondingly required to submit protected cell companies (PCC)/ multi class share vehicles (MCV) declaration, provide details relating to generic type of investors in the broad based fund, seek approval of the DDP for adding a new share class if the fund had segregated portfolios for each share class, seeking conditional registration for regulated funds, etc.

Under the 2019 FPI Regulations, the requirement to meet broad based fund criteria, including all erstwhile related requirements, have been done away with.

5.Restrictions relating to opaque structures removed

The requirement under the 2014 FPI Regulations for the FPI applicant not being an opaque structure has been done away with. Entities established as protected cell company, segregated cell company or with equivalent structures, which provides for ring-fencing of asset and liabilities across cell, share classes, etc. can now seek registration as FPI, subject to the FPI providing beneficial ownership details for each share for each cell/fund/sub-fund/share class/equivalent structure that invests in India.

6.Definition of ‘investment manager’ revised

Under the 2014 FPI Regulations, the scope of the term ‘investment manager’ also included an ‘investment advisor’. Under the 2019 FPI Regulations, the term ‘investment advisor’ has been deleted from the definition of ‘investment manager’, and is defined to include an entity performing the role of investment management or any equivalent role, including trustee(s). Hence any entity relying on its ‘investment manager’ for the purposes of its FPI registration or for dealing in offshore derivative instruments shall have to ensure that its ‘investment manager’ meets the revised requirements.

7.University related endowments to obtain Cat I FPI registration

Under the 2014 FPI Regulations, only university related endowments which were earlier registered with SEBI as FIIs / sub-accounts could have obtained Category II FPI registration. Going forward, any university related endowment, from a FATF member country, of a university which has been in existence for more than five years will be permitted to obtain Category I FPI registration.  Further an entity, whether or not from a FATF member country,  which is at least 75% owned, directly or indirectly by such university related endowment can also obtain Category I FPI registration provided the university related endowment undertakes the responsibility of all the acts of commission or omission of the applicant entity.

Eligibility Criteria
8.FPI applicant cannot be an overseas citizen of India

In addition to not being an Indian resident (IR) or a non-resident Indian (NRI), under the 2019 FPI Regulations, the FPI applicant cannot be overseas citizen of India (OCI). Further no changes have been made by SEBI relating to the single / aggregate NRI/OCI/RI contribution limits permitted in an FPI, and all existing FPIs or new FPI applicants who do not meet such requirements have to comply with such requirements within a period of 2 years from the date of its FPI registration or by 31st December 2020, whichever is later.

9.Certain specific eligibility requirements for erstwhile Cat III FPIs done away with

Earlier eligibility requirement for a Category III FPI of being legally permitted to invest in securities outside its country, being authorized by its charter documents, etc. to invest on its own behalf or on behalf of its clients, applicant having sufficient experience, good track record, is professionally competent, financially sound and has a generally good reputation of fairness and integrity, as well as grant of FPI registration to such applicant being in the interest of the development of the India securities market has been done away with.

Investment restrictions
10.Additional transactions which can be undertaken by a FPI without a stock broker

In addition to the nature of transactions that were permitted to be undertaken without a stock broker under the 2014 FPI Regulations, the following transactions are also now permitted to be undertaken by a FPI without a stock broker:

– transactions in unlisted securities received through involuntary corporate actions (this will include scheme for merger / demerger, in accordance with the Companies Act, 2013 or applicable SEBI guidelines), resolution plan or any action taken for debt resolution under the Insolvency and Bankruptcy Code, 2016, the guidelines issued by the Government of India or the Reserve Bank of India or any other regulator). Such unlisted holdings of the FPI would be treated as Foreign Direct Investment (FDI) and pricing guidelines for such sale will have to be as required under the foreign exchange laws in India.

– transactions for transfer of right entitlements, provided such transactions are undertaken at market price or fair value, as applicable.

– purchase or sale transactions of illiquid or suspended or delisted securities by an FPI in accordance with the pricing guidelines for such sale under the foreign exchange laws in India.

– transactions between FPIs under multi investment manager (MIM) structure having same beneficial owner and have common Permanent Account Number (PAN).

– transactions in corporate bonds by any FPIs. Under the 2014 FPI Regulations, such dispensation was provided only to Category I and Category II FPIs.

11.Clarification on investment limit for equity shares and divestment of excess holding

The 2019 FPI Regulations clarify that the total investment of a single FPI including its investor group in equity shares of a company has to be below 10% of the total paid-up equity capital on a fully diluted basis of the company. This language has now been harmonized with the language under the foreign exchange laws in India.

In the event the total investment under the FPI Regulations by an FPI and its investor group exceeds the said below 10% limit, the FPI is required to divest the excess holding within 5 trading days from the date of settlement of the trades. If such FPI and its investor group fails to divest the excess holdings or opts to treat their entire investment into a company as Foreign Direct Investment (FDI), then the entire investment in the company by such FPIs including its investor group would be considered as investment under FDI and thereafter no further portfolio investments in such a company under the 2019 FPI Regulations would be permitted to be made by such FPIs including its investor group. Such FPI/ its investor group are required to inform respective custodians of the option followed by them. Such investments shall be treated as FDI subject to norms as prescribed by the Reserve Bank of India from time to time. The FPI and its investor group will be permitted to sell such securities only through the route as they were acquired and appropriate reporting (i.e. LEC reporting) will be made by the respective custodian.

12.Clarification on the scope of investor group

The 2019 FPI Regulations clearly provides that multiple entities registered as FPIs, and directly or indirectly, having common ownership of more than 50% or common control shall be treated as part of the same investor group and the investment limits of all such entities shall be clubbed at the investment limit as applicable to a single FPI. Hence, entities which are not registered as FPIs will not form part of an investor group under the FPI Regulations and correspondingly would not be subjected to investment limits prescribed for FPIs under the FPI Regulations.

13.Entity registered as FPI also permitted make FDI, FVCI, etc. investments

The 2019 FPI Regulations specifically provides that an entity, registered as an FPI is permitted to invest in Indian securities as a person resident outside India in accordance with provisions of relevant Regulations made under the Foreign Exchange Management Act, 1999 (FEMA). Hence there is no restriction on an entity registered as an FPI to make investment under FDI, foreign venture capital investor (FVCI) and other permissible routes under FEMA.

14.Clarification on “to be listed” shares

FPIs are permitted to acquire “to be listed” shares pursuant to initial public offer (IPO), follow-on public offer (FPO), rights issue, private placement or shares received through involuntary corporate actions including a scheme of a merger or demerger.

Offshore Derivative Instruments (ODI)
15.Definition of ODI revised

ODI has been defined to mean “any instrument, by whatever name called, which is issued overseas by a FPI against securities held by it in India as its underlying”.  The earlier reference to “listed or proposed to be listed on any recognised stock exchange in India, or unlisted debt securities or securitised debt instruments” in the definition of ODI has been deleted.

16.Permissible ODI issuers and holders

ODIs can be issued only by registered Category I FPIs.

ODIs can only be held by persons eligible to obtain registration as Category I FPIs. The requirement under the 2014 FPI Regulations for an ODI holder to be regulated by

an appropriate foreign regulatory authority has been done away with. Under the 2019 FPI Regulations, even an unregulated entity which is eligible to obtain registration as a Category I FPI is now be permitted to hold ODIs.

Sl. No.ODI reference/ underlyingODI issuer’s holding in India against the ODIAllowedException
1.Cash equity/ debt securities / any permissible investment by FPI (other than derivatives)Cash equity/ debt securities / any permissible investment by FPI (other than derivatives), for life of ODIYesNone.
Separate registration required to undertake any proprietary derivative transactions by such ODI issuing FPI.
2Cash equityCash equity on date of writing the ODIs and then move to derivative positions thereafter.NoAllowed through separate FPI registration, subject to the above 5% limit.
3Cash equityDerivative on date of writing the ODI or thereafter except in manner referred at (2) above in table.NoNone
4DerivativesDerivativesNoAllowed through separate FPI registration, if FPI is holding cash equity and has short future position exactly against the cash equity in the same security (one-to-one basis).

FPI to retain the cash equity for the life of ODI.

5DerivativesCash equityNoNone

As per the 2019 FPI Regulations, in the event to be eligible to obtain Category I FPI registration, the ODI holder is required to rely on its investment manager, then in such cases only meeting the criteria relating of the investment manager being from an FATF member country would suffice for the ODI holder being considered to be eligible to be a Category I FPI, and such investment manager would not be required to be registered as a Category I FPI.

Category II FPIs or persons who would be categorized as Category II FPIs cannot deal in ODIs.

The Operational Guidelines provides that ODI holders not meeting these requirements can continue to hold existing positions till December 31, 2020. No renewal/rollover of existing positions by such ODI subscribers shall be permitted and fresh issuance of ODIs shall be made only to eligible subscribers.

17.Reference/ Underlyer / hedging of ODIs

SEBI has under the Operational Guidelines provided that FPIs shall not be permitted to issue ODIs referencing derivatives. Further, no FPI shall be allowed to hedge their ODIs with derivative positions on stock exchanges in India, except when a separate FPI registration is taken by such ODI issuing FPI for :

(a)  derivative positions taken on stock exchanges for ‘hedging of equity shares’ held by it in India, on a one to one basis.

The term “hedging of equity shares” means taking a one-to-one position in only those derivatives, which have the same underlying as the equity share held by the FPI in India.

(b)  hedging the ODIs referencing equity shares with derivative positions in Indian stock exchanges, subject to a position limit of 5% of market wide position limits for single stock derivatives. The permissible position limit for stock index derivatives is higher of INR 1000 million or 5% open interest.

Proprietary derivative positions by ODI issuing FPI which hedges its ODI only by investing in securities (other than derivatives) is not required to obtain a separate FPI registration for taking proprietary derivative positions.

No fresh derivative position which are not in compliance with above requirements shall be allowed henceforth.  FPIs have been provided a time period of 90 day from date of the Operating Guidelines to comply with above requirements. Off-market transfer of assets/ positions have be allowed for FPIs intending to transfer assets/ position from one FPI account to another FPI account to comply with above requirements.

General obligations
18.KYC of shareholders / investors of FPIs

The 2019 FPI Regulations specifically provide that FPIs are required to undertake necessary KYC on its shareholders/investors in accordance with the rules applicable to it in the jurisdiction where it is organized.

19.FPI held securities to be free from encumbrances

Under the 2019 FPI Regulations, FPIs have been imposed with the obligation to ensure that securities held by FPIs are free from all encumbrances. Under the 2014 FPI Regulation, this obligation was imposed on the DDPs to ensure that FPIs meet such requirements.

Other Changes
20.appropriately regulated entity

The term “appropriately regulated” entity has been defined to mean “an entity which is regulated by the securities market regulator or the banking regulator of home jurisdiction or otherwise, in the same capacity in which it proposes to make investments in India.”. Hence even if the applicant is regulated by such regulators in a jurisdiction other than the home jurisdiction, the applicant will be considered to be regulated. Further, in the Operation Guidelines, SEBI has also clarified that certain type of structures in some of the jurisdictions which were permitted by SEBI in the past shall continue to be considered as appropriately regulated.

21.FPI Registration application Form

SEBI has prescribed a new FPI registration application Form under the Operational Guidelines. Under the said Form the applicant will also be required to provide the following information :

– legal entity identifier of the applicant.

– whether a segregated portfolio is maintained for sub-funds / share classes of the applicant and details thereof (if applicable)

– the FPI applicant is also required to provide disclosures on whether there has been any instance of violation or non-adherence to the securities laws, code of ethics/ conduct, code of business rules, for which the applicant or its parent/holding company or associate / or promoter/ investment manager may have been subjected to criminal liability or suspended from carrying out its operations or the registration, has been revoked, temporarily or permanently or any regulatory actions that have resulted in temporary or permanent suspension of investment related operations in the applicant’s home jurisdiction and has a bearing on obtaining FPI registration for investing in India.

22.Applicants from International Financial Services Centre (IFSC) can also seek registration as FPI

Entities established in International Financial Services Centre are also permitted to seek registration as an FPI. Such entities would be deemed to be appropriately regulated.

23.Offshore funds  under SEBI Mutual Funds Regulations – FPI Registration

SEBI has clarified that offshore funds floated by asset management companies who have received no-objection certificate in accordance with the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996 and making investment in Indian securities would be required to obtain FPI registration within 180 days from notification of the 2019 FPI Regulations.

24.Appropriately regulated entities investing on behalf of their client

Appropriately regulated entities such as banks and merchant banks, asset management companies, investment managers, investment advisors, portfolio managers, insurance & reinsurance entities, broker dealers and swap dealers are now permitted to undertake investments on behalf of their clients as Category II FPI (in addition to undertaking proprietary investment by taking separate registrations as Category I FPI), subject to following conditions :

i.        Clients of such FPI can only be individuals and family offices.

ii.    Clients of such FPI should also be eligible for registration as FPI and should not be dealing on behalf of third party.

iii.  If the FPI is from a FATF member country, then the KYC including identification & verification of beneficial owner of the clients of such FPI should be done by the FPI as per requirements of the home jurisdiction of the FPI.  FPIs from non-FATF member countries should perform KYC including identification & verification of beneficial owner of their clients as per Indian KYC requirements.

iv.  FPI has to provide complete investor details of its clients (if any) on quarterly basis (end of calendar quarter), by end of the following month to DDP as specified by SEBI.

v.    Investments made by each such client, either directly as FPI and/or through its investor group shall be clubbed with the investments made by such clients (holding more than 50% in the FPI) through the above reference appropriately regulated FPIs.

25.Applicants having segregated portfolios for separate share classes

FPIs having segregated portfolio(s) for its sub-fund/share class/equivalent structure are required to provide beneficial ownership (BO) declaration for each fund/sub-fund/share class/equivalent structure that invests in India. Further, in case of addition of fund / sub fund / share class /equivalent structure with segregated portfolio that invests in India, the FPI shall be required to provide BO information prior to investing in India through such new fund/sub fund/share class/equivalent structure.

Existing FPIs with segregated portfolio are required to provide the BO details for each fund/sub-fund/share class/equivalent structure that invests in India at the time of continuance of registration or within six months from the date of notification of the 2019 FPI Regulations, whichever is later. In case of non-submission of BO details within six months, the FPI shall not be allowed to make fresh purchases till the time it is compliant with the said requirement.

26.Changes in Fees

The registration fee for Category I FPIs would be USD 3000 and for Category II FPIs would be USD 300, which fees would be valid for every block of three years

Date: November 13, 2019