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SEBI cracks the whip

September 5, 2018 | Expert Insights

India’s securities regulator issues a new order which will no longer recognise People of Indian Origin (PIOs) as ‘foreign portfolio investors’.

This move is directed to prevent the hoarding of wealth outside India.

Background

The Securities and Exchange Board of India is the regulator for the securities market in India. It was established in the year 1988 and given statutory powers on 30 January 1992 through the SEBI Act, 1992.

SEBI has been vital in the fight against unaccounted money and tax evasion in India. Through various notices and announcements, SEBI enforces strict compliance of standard banking and transactional regulations on domestic and foreign investors. Additionally, it protects the end consumer of these financial services from fraud and deception.

India has struggled with unaccounted wealth being accumulated outside its jurisdiction in tax havens. Some of these tax havens like Switzerland have agreed to comply with government requests for information on account holders.

In 2016 New Delhi ended a longstanding arrangement with Mauritius under which investments made through that country had been exempt from capital gains tax. Last year SEBI imposed strict rules on participatory notes — instruments widely used to make offshore investments in Indian securities — prompting a sharp fall in their usage. 

Analysis

Asset managers are warning Indian regulators of a potential hit to the country’s capital markets from rules targeting foreign investors with Indian heritage. From the end of this year, entities owned by people of Indian origin will not be allowed to operate as foreign portfolio investors, under an order from the Securities and Exchange Board of India (SEBI). 

The move is aimed at stamping out the practice of “round-tripping”, whereby citizens have used relatives abroad to launder money and make investments in India while concealing their wealth from authorities. A crackdown on tax evasion has been one of the signature policies of Prime Minister Narendra Modi’s government.

This is just the latest move by Indian authorities to crack down on offshore money laundering. However, the rules could result in the liquidation of positions worth billions of dollars.

Close to $75bn of foreign portfolio investment into India was handled by fund managers of Indian origin. Where there is no single main owner of a fund, its “senior managing official” will be considered the beneficial owner, according to the new rules.

Should regulators enforce the rules from year-end as planned, the $75 billion investment will be disqualified from investing into India and will have to be withdrawn and liquidated within a short timeframe.  This will adversely affect the Indian markets and the Indian currency.

The controversy threatens to cast a further shadow over sentiment after a period of weak foreign portfolio investment, where India has had net outflows of Rs. 430bn ($6bn) this year, a reversal from net inflows of Rs. 2 trillion in 2017.

SEBI has given the investors six months to adhere to the new rules; the deadline for compliance was extended till the 31st of December 2018. It has also set up a committee under HR Khan, a former deputy governor, to look into various acts and rules related to Foreign Portfolio Investments s in India.  It has also clarified that the circular was part of its efforts to curb the flow of funds from suspected sources abroad.

SEBI dismissed the suggestion that all the investments in question would be liquidated as “preposterous and highly irresponsible”. 

Assessment

Our assessment is that SEBI’s latest circular is a part of a larger effort to root out illegal wealth hoarding and unaccounted money from the capital markets. The move is in accordance with the Parliament’s acts on black money and foreign investments. We feel that SEBI has taken a credible step in fighting suspicious foreign funding in Indian capital markets. However, we also feel that it should take into consideration the massive negative impact of nullifying such a large amount of foreign investment in India.