Liberalize investment cap, review restrictions for FPIs, says Sebi panel

Currently Sebi has divided FPIs into three categories. Photo: Reuters

MUMBAI: A Securities and Exchange Board of India (Sebi)committee has suggested a slew of changes in rules for foreign portfolio investors, which could usher in a second round of reforms for foreign investors, if implemented.

The report of the committee, headed by former Reserve Bank of India (RBI) deputy governor H.R. Khan, was released by Sebi on Friday.

The key changes suggested include lifting restrictions on foreign portfolio investment (FPI) limits, easing registration processes for well-regulated entities, insurance companies and pension funds, and reclassifying FPI to foreign direct investment (FDI).

The panel suggested that Sebi should have a discussion with the RBI and the government to tweak the caps for FPIs.

Currently, FPIs are capped at 24%, which can be taken to the sectoral foreign investment limit (FPI+FDI) through board and shareholder approval. The panel said that the companies were not doing so. To give more room to foreign portfolio investors to invest in Indian stocks, the panel suggested that they can invest up to applicable sectoral limits after adjusting for investments made under the FDI route.

“An important determinant of attracting cross-border investments is availability of investible stock to the FPIs. This issue assumes greater significance, in view of the gradual shift from stock-targeted investments towards passive investment, whereby funds track global indices composition, which depends upon available floating stock,” said the Khan panel.

The panel also suggested that limits applicable for FDI in certain sectors should not be applicable for FPI. “Given that FPIs do not exercise any control or influence, it is proposed that prohibition relating to foreign investments in certain sectors should be limited to FDI, and not be extended to FPIs. However, such FPIs’ existing investments, including ADR and GDR, may not exceed 49%,” it added.

Tejesh Chitlangi, senior partner, IC Universal Legal, said: “The recommendations aim to simplify the FPI regulatory regime and address several practical issues, which have been of concern over a long period of time. Recommendations pertaining to fast-tracking of on-boarding process, default increase in the investment limits up to the sectoral caps, KYC simplification, allowing FPIs to deal off-market, etc., would boost the registrations and investments, if implemented. Also, several recommendations pertaining to the broad basing, clarification on “to be listed shares”, clarity on FPI-FDI interplay, etc., would remove current grey areas/ambiguities.”

Currently, Sebi divides foreign portfolio investors into three categories. Category-I typically includes foreign central banks, sovereign wealth funds and government agencies with minimal compliances. Category II includes banks, asset management firms and investment managers who need to fulfil the criteria of being broad-based (more than 20 investors) at all points in time. Category III typically includes hedge funds—a class of investors that has onerous compliance requirements to meet.

The panel said that pension funds, which currently fall in category II, are generally perceived to be low-risk investors and this made a strong case for migration to category I. Similarly, it made a case that insurance firms should be deemed to be treated as broad-based. Category-III funds have higher compliance requirements and documentation such as integrity certificate and legal permissibility certificate. It proposed to do away with this requirement, saying Sebi in any case requires all FPIs to be “fit and proper”.

The panel also proposed changing the broad-based fund definition on the basis of economic ownership and not just the number of investors. The underlying investor should hold at least 25% in the fund for it to qualify as broad-based. It proposed that FPI category III coming from non-high risk jurisdictions will need to comply with KYC requirements of category II.

Sebi has invited comments till 14 June.