SEBI’s new framework: Enhancing transparency for FPIs, ODIs, and P-Notes

The Securities and Exchange Board of India (SEBI) has recently proposed significant changes to the registration and regulatory framework for Foreign Portfolio Investors (FPIs) concerning Offshore Derivative Instruments (ODIs) and Participatory Notes (P-Notes). These changes aim to enhance transparency, reduce regulatory arbitrage, and ensure a more robust regulatory environment for foreign investments in India.

Understanding FPIs, ODIs, and P-Notes

Foreign Portfolio Investors (FPIs) are entities that invest in Indian securities, including shares, government bonds, corporate bonds, and derivatives. FPIs play a crucial role in the Indian financial markets by providing liquidity and promoting market efficiency.

Offshore Derivative Instruments (ODIs), commonly known as Participatory Notes (P-Notes), are financial instruments used by investors or hedge funds that are not registered with SEBI to invest in Indian securities. These instruments are issued by registered FPIs to overseas investors, allowing them to gain exposure to Indian markets without directly registering with SEBI.

Proposed Changes by SEBI

The Securities and Exchange Board of India (SEBI’s) proposed changes focus on several key areas to address existing challenges and improve the regulatory framework for FPIs, ODIs, and P-Notes:

1. Enhanced Disclosure Requirements: The Securities and Exchange Board of India (SEBI) plans to extend the granular disclosure norms currently applicable to FPIs to ODIs and P-Notes. This includes detailed disclosures on beneficial ownership, economic interest, and control. The aim is to ensure greater transparency and traceability of investments made through these instruments.
2. Prohibition on Derivatives: SEBI proposes to prohibit the issuance of ODIs with derivatives as the underlying asset. This move is intended to curb speculative activities and ensure that ODIs are used primarily for genuine investment purposes. ODIs will only be allowed to have cash equity, debt securities, or other permissible investments as underlying assets.
3. Separate FPI Registration for ODIs: To further tighten the regulatory framework, SEBI suggests that ODIs should be issued only through separate, dedicated FPI registrations. This means that entities issuing ODIs will need to obtain a distinct FPI registration, separate from their proprietary investments. This measure aims to prevent conflicts of interest and ensure better monitoring of ODI issuances.
4. Concentration and Size Criteria: SEBI has proposed applying concentration and size criteria directly to ODI subscribers. This includes monitoring the exposure of ODIs to specific corporate groups and ensuring that the total value of ODIs as a percentage of the assets under custody (AUC) of FPIs remains within specified limits. This measure is designed to prevent excessive concentration of investments and mitigate systemic risks.
5. Regulatory Arbitrage: The proposed changes also address regulatory arbitrage by ensuring that investments made through ODIs or segregated portfolios of FPIs are subject to the same set of disclosure and regulatory requirements as regular FPIs. This includes identifying beneficial ownership, economic control, and economic interest on a look-through basis.

Implications of the Proposed Changes

The proposed changes by the Securities and Exchange Board of India (SEBI) are expected to have several implications for the Indian financial markets and foreign investors:

1. Increased Transparency: The enhanced disclosure requirements will lead to greater transparency in the market, making it easier for regulators to track and monitor foreign investments. This will help in identifying the ultimate beneficial owners of investments and prevent the misuse of ODIs for illicit activities.
2. Reduced Speculation: By prohibiting the use of derivatives as underlying assets for ODIs, SEBI aims to reduce speculative activities and ensure that ODIs are used primarily for genuine investment purposes. This will contribute to the stability and integrity of the Indian financial markets.
3. Improved Regulatory Oversight: The requirement for separate FPI registrations for ODIs will enable better regulatory oversight and monitoring of ODI issuances. This will help in preventing conflicts of interest and ensuring that ODI issuers comply with regulatory norms.
4. Mitigation of Systemic Risks: The application of concentration and size criteria to ODI subscribers will help in preventing excessive concentration of investments and mitigate systemic risks. This will contribute to the overall stability of the financial system.
5. Level Playing Field: By addressing regulatory arbitrage, SEBI aims to create a level playing field for all investors, ensuring that investments made through ODIs or segregated portfolios of FPIs are subject to the same regulatory requirements as regular FPIs. This will promote fairness and integrity in the market.

Conclusion

SEBI’s proposed changes to the FPI registration and regulatory framework for ODIs and P-Notes represent a significant step towards enhancing transparency, reducing regulatory arbitrage, and ensuring a more robust regulatory environment for foreign investments in India. These changes are expected to contribute to the stability and integrity of the Indian financial markets, making them more attractive to genuine long-term investors.

As SEBI invites public comments on these proposals, it is essential for stakeholders, including FPIs, ODI issuers, and investors, to provide their feedback and suggestions. The successful implementation of these changes will depend on the collective efforts of regulators, market participants, and investors to create a transparent, fair, and efficient financial market in India.