Sebi’s tight ownership rules can spark a potential stock sell-off by foreign investors; What will happen after February 1?

As the calendar flips to February 1, 2024, the Securities and Exchange Board of India (Sebi) stands firm on its decision to implement stringent ultimate beneficial ownership norms for overseas investors. Despite pressure from foreign banks and offshore fund managers, Sebi remains resolute, setting the stage for a transformative shift in India’s financial landscape.

Sebi’s Ownership Norms and Potential Sell-off

Sebi’s tightened ownership norms, set to be enforced from February 1, pose a significant challenge for foreign portfolio investors (FPIs). Analysts estimate a potential sell-off ranging from Rs 1.5 lakh crore to a staggering Rs 72 lakh crore over the next six months by funds unable to comply with these regulations. The capital markets regulator introduced these norms in August 2023, responding to concerns about opacity in the ownership structure of overseas entities, particularly those invested in Adani Group companies.

Granular Disclosure Requirements

The new regulations necessitate high-risk foreign funds, constituting an estimated AUM of Rs 2.6 lakh crore as of March 31, 2023, to provide detailed information on all entities holding any ultimate beneficial ownership. FPIs holding more than 50% of their Indian equity AUM in a single corporate group or those with over Rs 25,000 crore of equity AUM in Indian markets must adhere to these stringent norms. The grace period provided by Sebi allows these funds time to disclose investor details. However, failure to comply within the stipulated time frame comes with consequences.

Implications and Potential Market Dynamics

As the compliance deadline approaches, overseas investors not positioned to disclose ultimate beneficiaries are already initiating the sale of their Indian holdings. Experts note a flurry of activity among FPIs as they grapple with the granular disclosure requirements. Siddharth Shah, a partner at Khaitan & Co., emphasises that funds facing challenges in meeting these standards have begun reducing their exposure to Indian markets. Particularly, fund managers with higher non-institutional capital are finding it challenging to navigate the intricate disclosure standards.

Select Exemptions and Evaluations

Sebi has granted exemptions to select foreign fund categories deemed “genuine.” These exemptions, in line with section 43B of the FPI regulations, offer relief for non-compliance arising from factors beyond the entity’s control or technical violations. Categories such as foreign government funds, offshore public retail funds, and pension funds, considered ‘low-risk’ and ‘moderate-risk’ FPIs, have already received leeway. Sebi is further evaluating additional categories of FPIs that may be exempted from granular disclosure, striking a balance between regulatory rigor and facilitating legitimate capital formation.

Challenges for Smaller FPIs

Non-compliance is more likely among FPIs holding more than 50% of their Indian equity AUM in a single domestic corporate group. Consultants advising foreign investors note that smaller global funds, including newly registered ones, investing in a limited number of Indian stocks, may be particularly affected. The granular disclosure standards, although aimed at transparency, pose challenges for funds with concentrated holdings.

Conclusion

As the February 1 deadline approaches, Sebi’s unwavering stance on tightened ultimate beneficial ownership norms heralds a new era for FPIs in India. The potential sell-off, ranging from significant to unprecedented, underscores the magnitude of regulatory changes. The financial landscape is witnessing a paradigm shift as FPIs recalibrate their portfolios. Striking a delicate balance between regulatory stringency and facilitating genuine investment, Sebi’s evolving exemptions reflect a nuanced approach. Investors and market participants must brace for imminent changes, as India’s financial markets stand at the crossroads of regulatory evolution.

Disclaimer: This blog has been written exclusively for educational purposes. The securities mentioned are only examples and not recommendations. It is based on several secondary sources on the internet and is subject to changes. Please consult an expert before making related decisions.