Capital market regulator Security Exchange Board of India (Sebi) recently made changes to the KYC framework for Foreign Portfolio Investors (FPIs) through a circular on April 10, 2018.

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Under the Sebi (Foreign Portfolio Investors) Regulations, 2014 (FPI Regulations), NRIs are not eligible to obtain registration as FPIs.

In relation to Indians as beneficial owners of FPIs, the circular has also confirmed the guidance, which was previously available under the Sebi FAQs that NRIs/OCIs cannot be beneficial owners of FPIs.

>>FPI managers club: Indians not allowed

Nandita Agarwal Parker, president, Asset Managers Roundtable of India (AMRI), Nishith Desai of Nishith Desai Associates, Anjani Sharma, partner, KPMG, Sudhir Kapadia, partner and national tax leader at EY India discuss the issue.

Edited Excerpts:

Essentially what Sebi is saying is that an Indian origin person cannot be a beneficial owner in offshore fund investing in India. Beneficial ownership is linked to control, so if I as an Indian float offshore fund and I raise money and I have the management share, I have control as I am the beneficial owner. But according to the new rule – I cannot be the beneficial owner, I essentially cannot manage that fund, I will have to get somebody a foreigner for example and Sebi would be okay with it that is essentially where the regulation stands as of now. Did I put it aptly, did I describe the situation as it is?

Parker: Let me just also point out that I am representing not just Karma Capital but also the industry. All the foreign fund managers of Indian origin, as well as the resident Indian fund managers, have come together. This is the first time we have formed an association called Asset Managers Roundtable of India (AMRI) and we are speaking with one voice.

So, just to be sure I am batting for the industry and not my own personal interest although they are very much at stake here.

It is for us an existential issue to be or not to be. The way things stand it is not going to be and that is not good. The reason why Nishith Desai and I had the press conference today (Monday) is to really raise the profile of this issue because although it has been trickling in the press there really hasn’t been full on the understanding of what is it states and maybe the powers that we don’t realise. What it states, especially in an election year, the unintended consequence of this circular is that about $75 billion of investment will have to be unwound.

Let me just break that question down into two parts because what the circular is saying on one hand are these threshold triggers that will determine who is the beneficiary owner of this sort of investment vehicle, there can be 15 percent, there can be 10 percent, there can be 25 percent depending on how you are looking at the structure of the trust?

Parker: That is from an economic interest standpoint

That is one aspect and then there is the actually management and control where you as head of Karma Capital may not have more than 15 percent economic interest yet are exercising managing control, where does the problem lie?

Parker: The problem is that no institutional investor or anybody would give money to an entity that doesn’t have a controlling person. So, there has to be a fund manager in charge and the minute you say I am the fund manager in charge and I am of Indian origin this circular says well you can’t be. You cannot come, you cannot utilise the FPI route to bring in investments into India.

So, Nandita Parker cannot be the fund manager for Karma Capital? Will it have to be a foreigner?

Parker: Exactly, so anybody of Indian origin even cannot be a fund manager of offshore money coming through FPI route into India. What that means is if NRIs want to invest in India they would not come through my fund they could come through a foreign fund.

A Nigerian could set up a fund and invest through the FPI route. A Russian can do it, but I, who have been postulating India investment case for 25 years, wrote first India’s strategy report 1995 and have been an ambassador for India, can’t do it.

If I try and play devil's advocate or look at it from the government's point of view to understand where this is coming from, the idea was to make sure there is no round tripping, the idea was to make sure that the Prevention of Money Laundering Act's (PMLA) execution is water tight etc. What have I heard in terms of some of the counter claims is that what is so wrong if Sebi and the government want an FPI entity to be widely held? So, no Indian should own more than 15 percent or 10 percent, whatever the thresholds as they may apply. Is the problem really with thresholds or is the problem with managing that fund irrespective of the Indian person's economic interest?

Desai: Fundamentally we have to find out what is the object and purpose of this whole circular. As an industry they are absolutely clear in relation to disclosure norms, howsoever strict they are as far as beneficial ownership is concerned.

There is absolutely no ambiguity that they are willing to disclose whatever information they have in their possession but the way in which the beneficial ownership has been defined, that is where the problem is. It includes any manager who manages the fund if he happens to be a Non-resident Indian (NRI), Overseas Citizen Of India (OCI), Persons of Indian Origin (PIO) or even reputed Indian resident institution, the whole thing is that it is very broadly defined.

If the intention is to collect information with economic ownership what is really required, if money is laundered, you need information, I think nobody has a quam with that at all. However, the way in which the circular has come out it almost puts total ban on any foreign fund which is managed by NRI, Overseas Citizen Of India OCI, PIO and Resident Indian institution which are actually approved and often encouraged by Indian government in the last few years to mobilise funds from abroad, channelise them into India and invest. So, that is the crux of the issue.

As far as the circular is concerned, I think the industry felt that normally Sebi has a very healthy practise of engaging the stakeholders before any circular is issued or any regulation is issued, somehow or the other this time it was not done, so they are little agitated that at least if you would have told us we would have helped you and we are here to help.

I think you used word protest, it is not to protest but I think the idea is to see how you can cooperate and work together so that we get capital and a capital that is good capital not a tainted capital, this is the objective and let us work together, that was the tenor of their presentation.

Desai said even Indian entities like Edelweiss, Reliance, Birla who essentially may have floated overseas funds and they have fund managers sitting here in India, how do they get impacted because there is a clear owner, right? If it is Reliance which has floated Reliance Mutual Fund the beneficial owner would be Reliance Capital, how does this impact? So, resident Indians are also banned from managing foreign money?

Parker: Yes, as per the circular.

What about GMO for example which invests in India, it has got somebody out of Singapore managing money into India, would they also get impacted?

Parker: I am not sure but quite likely.

Just to understand what the basic grouse is, would you and some of the members of the association, would they be okay with the owning entity, the single Indian entity owning less than 15 percent, so the thresholds are not a problem then?

Parker: There are three thresholds -- 25 percent, 15 percent and 10 percent. The high risk jurisdiction has not been clarified as yet, so that is an issue that is out in the open.

There is enough ambiguity in the circular, it is not something that you and I can sit and negotiate here. It really needs to be looked at in terms of an overall picture from different standpoints, like does it impact GMO. The point is what are you trying to achieve?

I am coming back to the central matter here, the intent being to make sure that there is no more round tripping, I think that would have been curbed to a large extent, we have tightened treaties, we have put guards in place, there is so much that has happened already, so is this getting a little excessive?

Sharma: The whole concept of beneficial ownership, it was there with Sebi but what they have now done is, they have tried to align it with the Money Laundering Act and the way now it comes out is, if you borrow stuff from PMLA, it says that your beneficial owner has to be a natural person, a person you can identify and point and put behind bars if anything goes wrong.

That is where one of the question which Nandita was asking how does the fund, let us say if somebody is sitting here at Edelweiss or any other person gets impacted? Because they want to know who is the guy who is calling the shots, ultimately who is the person who is in control? As you would understand, if it is Indian markets, guys who know or understand the markets well are the people who are related to this soil, right?

If I look at it a few years back, the government tried to bring in the whole fund manager industry into India by relaxing the tax norms, they were encouraging this. Now when Sebi is coming out with the beneficial ownership circular, there is nothing wrong about the circular, it is good, you want to see whether there is any laundered money or the money which is coming is a legitimate money, there is nothing wrong about it, people are ready to disclose whatever it makes it to disclose that.

The issue is the person who is managing, if he is supposed to be the beneficial owner then there are unintended consequences, your clubbing of limits are there, it says that if you cannot identify the senior management official, FPI would be termed as the beneficial owner.

Now that guy would be managing 10 funds, they are promoting India in a way, they are getting people to invest, all funds are having different strategies, they are mutually exclusive in that sense, right? One guy is managing everything. So, it becomes a little difficult to say that he becomes the beneficial owner and then everything collapses, that is where the problem is.

Beneficial ownership context is good, you have borrowed it from PMLA but PMLA also does certain exemptions like category 1, category 2, funds which are listed are not exempted today, while in PMLA that is there.

Parker: PMLA does not prohibit anybody from using the FPI route. It is only for KYC which we are happy to disclose. Therefore, it cannot be used or misused or misinterpreted by another agency.

What is your sense if the intention of the circular from Sebi is not prohibiting Indian origin people from getting overseas money into the country and managing it, what is the road ahead according to you?

Kapadia: As Nandita said that was what was expected since May, June this looked to be a very simple, unintended consequence and should have been sorted out very quickly, but for some reason, it is not.

In my view, what is happening is the objective of “trying to police” the so called or alleged money laundered funds. With that, the governance of the fund management industry has got a bit confused in this circular.

What I mean by that is if the intention and nobody can deny that objective should be there with any regulator that you want to prevent money laundering. As Nandita pointed out you have the PMLA. What is the objective of that? The objective of that is catch hold of a person who has allegedly misappropriated or syphoned of funds and after that, the law takes over.

As opposed to what this circular, unintentionally no doubt seems to be doing is actually shutting down that business altogether and you just cannot do it. It is prescribed, it is prohibited and that is the issue. The issue is not about compliance, it is not about KYC, the issue is not about pinpointing with specificity and who is that individual whom you found from your investigation has indulged in some wrong doing go after it.

The point is you do not want to shut down the whole window, the whole channel which has representation which could impact $75 billion being managed by people of Indian origin. When you believe that $1 billion, out of that could be such funds for example unless you believe the other way around. That is the issue.

The problem is right now we do not know what the real intention of this circular, till we hear officially from either the Sebi or the representative from the ministry, we do not know what they are thinking. So if the intention is to make sure that no Indian origin fund manager can have more than 10 or 25 or 15 percent depending on thresholds and they cannot have more than this much economic interest in the fund. Then is that even a valid contention to have from the government’s point of view or from Sebi’s point of view?

Kapadia: The threshold part is one thing and the industry can have a view on what should be the right threshold. But as was discussed the issue is not as much about the threshold percentage as it is about bringing the concept of beneficial ownership linked to control and that is where the main crux of the issue is.

In your quest to ‘try and police’ this alleged movement of funds or round tripping of funds from India back in, you are now prescribing that anyone of Indian origin, who is a beneficial owner in a fund, which he or she is controlling is impacted and you cannot have that person in charge there.

Even if those funds do not close down, you will replace them with pure foreigners, so what is the purpose being served. That is the crux of the issue, which should not be very difficult to clarify for the regulators. The reason why they are taking so long is a mystery.

What should be the threshold 10-15 percent, will that work?

Parker: Those are something that we have lived with. We haven’t had a discussion on thresholds, so I am not at liberty to really speak for my peer group. But I think are a reasonable amount should be allowed as seed capital from a sponsor. So, 25 percent is seed capital and government is well aware.

What are the current norms for seed capital?

Parker: There aren’t any, the government themselves has become a sponsor of their sovereign wealth fund, they should know that when you float a fund the outside investor expect the fund manager to put substantial skin in the game.

Now if you say, for the government skin in the game is 20 percent or globally accepted there is no norm as such but around 25 percent sounds reasonable but for Indians it should be 5 percent, 3 percent or two and a half percent – some random number, so where does that come from and what are you trying to achieve. This is the whole point.

Also, there is a question of NRIs coming in. Earlier there was sort of notion that there can be an almost unlimited NRI investment in any fund or most of us thought that of as 50 percent limit, so we went by that as industry practice more than a given threshold.

Now if you say there is the question of that limit and NRIs can only go through another route -- through a foreign fund manager. The first problem with that limit is that how do you define NRI, and which form should I have and what check box it have.

Should it be based on a person’s race and if they are 10 percent NRI, if their grandfather was a person of Indian origin -- this is craziness. I have never heard of any country discriminating against its own people and this is what the circular has amounted to.

When I have discussed it globally with investors, they are shocked and I am ashamed of having to explain this to people that anybody sitting over in India would come up with something like this.

As we just heard Nandita say. I don’t know if there are too many global precedence to this and, of course, it will be all very well if this is resolved amicably much before the December 31 deadline. But otherwise what legal recourse and how do you see the next several weeks and months progressing?

Desai: First of all I hope that this issue will be resolved, now that it is escalated a little bit so people would be understanding they are total implications of the new circular.

Second thing is that as far as the repercussion are concerned, we are creating an environment of uncertainty. People can understand things that are out of our control. But when the things are under our control we should have clarity and that is what is often missing and flip-flop like few years ago we encouraged Indian residents and others to set up funds and bring the money into India and then suddenly we say no. So I think what we have been suggesting is that let us have a consolidated process. Let us bringing in something that is healthy and actually bring lot more healthy money into the country.

Once again nobody has qualm on the disclosure norms, if they are proper and what are appropriate in conformity with the PMLA and other regulations. I don’t think anybody has a doubt at least from the industry side about disclosures or to be a myth that people want to hide etc. That is why the representation has been asked about 10-12 questions to the government.

Government must come out and answer those questions that what is the purpose. If we know the purpose then we can help to achieve the objective. For everything that has been done, why this threshold, why that threshold, why beneficial membership.

So once we have a clarity we understand government’s perspective as well and respond in a logical manner. Today what is happening is that there is a lot of speculation going out. It was an intention of government like this, so we in a speculative way try to respond to that.

Now we have no idea as to what went behind, how it got developed, what are the nuances that we have to deal with high risk jurisdiction and all those kind of questions which came up because it was little difficult.

Some banks have considered some jurisdiction as high risk and some jurisdiction as a non-high risk. Some actually said that they have classified India as a high risk jurisdiction does it mean that we can’t get investment or what.

So, I think high risk jurisdiction simply means the jurisdiction which does not have a regime to deal with anti-money laundering when there is rule and framework in place. If that is in place and if the banks don’t follow then it should be regarded as a high-risk bank, not the jurisdiction.

So, there is difference between people who actually has to implement. So, one is a jurisdiction itself with a framework.

Second one is when people don’t comply and that happens so those one should be disqualified not the other one. Again all these banks are very reputed banks. They are doing whatever they can, but these are confusion, concepts we are bringing into the middle and your regulatory discretions is delegated to banks and that has resulted in even the investment restriction.

Very interestingly what has happening here is that you ask the banks to define high risk jurisdiction. Once high risk jurisdiction is defined that means the investments limits apply which is a Foreign Exchange Regulation Act (FERA) issue so we are mixing up this issues and I think if we sit together I am sure will be cleaned up.

First Published:Sept 3, 2018 7:08 PM IST