The Securities and Exchanges Board of India has proposed to tighten the disclosure norms for foreign portfolio investors. In March, SEBI had asked FPIs to disclose any material change in their structure and common ownership within seven working days. These changes seem to be the outcome of the Hindenburg episode that rattled Indian equity markets and shares of Adani firms for some time. SEBI should revisit its rationale for the disclosure requirements from FPIs and only ask for those limited disclosures that serve its purpose.
The story so far
One of the allegations in the Hindenburg report was that Adani Group companies were violating the minimum public shareholding (MPS) norms laid down by SEBI. The MPS norms require that a listed company in India should have at least 25 per cent of its shares held by the public. The Hindenburg report suggested that the group was investing in overseas funds, creating layers of such funds, and subsequently having foreign portfolio investors (FPIs) invest the funds back into the company. The ultimate owner, after combing through such multiple layers of ownership, therefore, was the Adani family, thus violating the 25 per cent MPS rule. FPIs are required to disclose certain specific information about their ultimate beneficial owners. When the Supreme Court set up a committee to look into the matter, one of its mandates was to assess whether SEBI had failed in regulating FPIs. The committee’s report suggests that SEBI had not slipped on this count.
MPS and FPIs
It is useful to ask what, if anything, Indian equity markets gain by the MPS rule, and consequently, the disclosure norms on FPIs. If you own a firm, the decision of how much of it to retain and how much to sell to the public should be your discretion. This decision is granted to the government as the deadline for public sector enterprises to follow the rule keeps getting extended. The logic of differentially applying the rule to private firms is unclear.
The regulator claims that if very few shares are held by the market, then the shares will not be very liquid, and will have a lower price. But this is detrimental to the promoter, and in the promoter’s interest to have a liquid market in its shares. If the promoter still chooses to not sell 25 per cent to the market, then that should be their decision. Similarly, wanting to have a complex shareholding structure should be the promoter’s right. If the regulator is worried about insider trading and price manipulation, then there are plenty of regulatory tools to deal with those. For example, SEBI recently proposed more changes to the existing Insider Trading Regulations. One can debate the necessity of these changes, but that is a separate issue. We need to look deeper into why promoters don’t like going to the market, instead of mandating that they do.
This brings us to the question of disclosure of ultimate beneficiaries of FPIs. It is entirely possible that you invest in a fund, which then invests in another fund in some other country and that fund ends up investing in an Indian firm. There need not always be something fraudulent about such a transaction. In a globalised world, such transactions are par for the course.
However, since the law exists, it must be followed. Since 2018, FPI disclosures have been limited to the definition of beneficial owner set under the Prevention of Money Laundering Act (PMLA). SEBI itself has admitted that FPIs have followed the letter of the law. However, as the Supreme Court-appointed committee suggests, SEBI was investigating the beneficial ownership of certain FPIs despite their compliance with the law. Why then did SEBI need to pursue this matter? Was SEBI overstepping its mandate in this pursuit? This is an important question raised by the Supreme Court-appointed committee that needs to be discussed more seriously. If India wants access to global capital, then the rules in India cannot be orders of magnitude more stringent than their global counterparts. While we may be correct in thinking that we are a big and attractive market, there may be a point where the costs of regulatory compliance, especially owing to the regulator overstepping its mandate, may overshadow any benefits to investors.
SEBI’s approach
The reasons for the two agencies concerned with ultimate ownership — SEBI, and the Directorate of Enforcement (ED) under the Prevention of Money Laundering Act (PMLA) 2005 — are different. SEBI should come at the ultimate ownership of funds in an FPI from the perspective of whether there is a violation of the MPS norms. The ED may want to know the ownership of FPIs for reasons that may have to do with the flow of funds for money laundering or terror financing. SEBI should therefore concern itself with knowing the composition of ownership of FPIs from its narrow perspective. The desire for complete surveillance of all activities based on an implicit suspicion needs to be questioned. SEBI had adopted the definition of an ‘ultimate owner’ from the PMLA. This is the correct approach, and SEBI should persist with it.
Renuka Sane is research director at TrustBridge, which works on improving the rule of law for better economic outcomes for India. Views are personal. She tweets @resanering
(Edited by Theres Sudeep)