The Securities and Exchange Board of India, the market regulator, has released a consultation paper aimed at addressing the regulatory arbitrage available to foreign investors investing directly in India through registration as a Foreign Portfolio Investor or its sub-accounts, and those investing through overseas derivatives instruments, also known as participatory notes.
An offshore derivative instrument, also known as a P-Note, is a financial instrument that FPI issues using shares it owns in India as the underlying against foreign tax havens like Mauritius, etc. The financial advantages of these holdings are passed to the ODI subscriber, even though the underlying equities are still owned by the ODI issuer or the FPI.
Foreign P-Note subscribers are exempt from registration requirements under this route; nonetheless, they must comply with KYC regulations as the FPI is registered in India. It is now permissible for Category-1 FPIs to issue ODIs against Indian assets.
A position limit of 5% of marketwide position limits for single-stock derivatives applies. In 2019, the regulator tightened the process to prohibit ODI issued against derivatives for speculative purposes, unless the derivative position was taken by the FPI on the Indian stock exchange to hedge equity shares held in India on a one-to-one basis and the hedge limited for the ODIs referencing equity shares. The regulatory body permitted a maximum allowable position limit of Rs 100 crore or 5% of the open interest for stock index derivatives.
The regulator published a circular in August 2023 requiring enhanced disclosure and permitting detailed disclosure on a full look-through basis if a foreign investor owns more than Rs 25,000 crore of equity AUM in Indian markets or more than 50% of its assets under management in a single corporate group in India. The FPI would have to sell its holding and leave the Indian market in the event of non-compliance.
The same compliance and concentration disclosure criterion has now been applied to ODIs by SEBI. Additionally, the proposal strengthens the transparency requirements for FPIs and ODIs at the segregated fund level.
Several segregated portfolios with various sub-funds or share classes were held by 35 FPIs as of July, according to the market regulator’s observation. Eight of these FPIs were able to maintain segregated portfolios with ten or more sub-funds apiece; one of them had as many as eighty-six sub-funds or share classes.
The designated depository participants and the ODI issuing the FPI will be responsible for supplying this information.
Use Of Derivatives By ODIs
The regulator permitted the hedging of ODI positions in the domestic market against shares of Indian stock derivatives or index derivatives. It is currently suggested to remove the exception that was granted in 2017. FPIs that issue ODIs will not be permitted to use derivatives to hedge their positions in India or to issue ODIs with derivatives as an underpinnings.
Furthermore, within a year of the proposed framework’s release, all current ODIs containing derivatives as their underlying will need to be redeemed. Only four ODI issuers, valued at Rs 3,075 crore, have outstanding ODIs that are derivatively hedged, according to the regulator.
Additionally, the regulator wants to restrict the issuing of ODIs to a separate, dedicated FPI registration, prohibiting the issuance of any proprietary investments.
