New FPI regime to keep off foreign funds with 'opaque' structures

Foreign funds with 'opaque' structures would not be allowed to invest in Indian capital markets under the streamlined Foreign Portfolio Investor (FPI) framework for overseas investors.

While the FPI regime which will kick in from next month, brings together all foreign investor classes such as Foreign Institutional Investors (FIIs), their sub-accounts and Qualified Foreign Investors (QFIs), it has divided FPIs into three categories as per their risk profiles.


All new foreign investors wishing to invest in Indian markets would also need to register as FPIs, according to the Securities and Exchange Board of India. However, SEBI said, "opaque structures" will not be allowed to register as FPIs.

FIIs use complex multi-fund structures for possible round-tripping or money laundering activities through such structures such as multi-class share vehicle (MCV) or protected cell companies (PCCs), according to SEBI.

PCCs comprise of various cells, having funds of various investors, but with legal segregation and protection of assets and liabilities for each cell.

To register themselves as FPIs, foreign funds would need to submit declaration and undertakings that they were not operating as PCCs, MCVs or any such equivalent structures.

"However, an FPI applicant will not be considered as opaque structure and will be considered for grant of registration if it is required by its regulator or under any law to ring fence its assets and liabilities from other funds / sub funds," SEBI said.

To be eligible to register as FPIs, the foreign fund should be structures being regulated in their home jurisdiction and the funds or their sub-funds should satisfy broad-based eligibility criteria.

The applicants should give an undertaking to provide information regarding its beneficial owners as and when SEBI seeks this information.

Under the new regime, select FPIs, excluding high-risk profile entities, only would be allowed to issue participatory notes.

P-Notes are widely used by overseas high net-worth individuals (HNIs), hedge funds and sub-accounts of foreign institutional investors to invest in Indian markets through registered FIIs as it saves them time and cost.

For the time being, however, foreign funds that have already issued offshore derivative instruments under the existing FII regime will be allowed to continue to make use of the tool in order to ensure a seamless transition, SEBI said.

"Unregulated" foreign funds will not be allowed to issue offshore derivative instruments.

"The ODI (offshore derivative instruments) positions under FII Regulations can continue under the Foreign Portfolio Investors (FPI) regime.

"Also the subscribers who have subscribed to ODIs under FII Regulations can continue to subscribe to ODIs under the FPI regime," SEBI said in a detailed note on its new FPI guidelines.

SEBI said existing entities, which did not have positions through P-Notes, can continue to issue these instruments to registered clients.

"ODI issuers may continue to issue ODIs to those subscribers even if there is a change in their investment manager, provided the incoming investment manager is a regulated entity," the regulator said.

While Category-I FPIs, which deal with entities backed by foreign government, can issue, subscribe to or otherwise deal in ODIs in the same manner as it is being presently done under the FII regime, SEBI has prohibited certain entities under 'Category-II,' or medium-risk investors, from issuing P-Notes.

"Provided that those unregulated broad-based funds, which are classified as Category-II foreign portfolio investor by virtue of their investment manager being appropriately regulated, shall not issue, subscribe or otherwise deal in offshore derivatives instruments directly or indirectly," SEBI said.

All other FPIs would come under Category-III.