India – SEBI Prohibits Issuance Of Offshore Derivative Instruments By FPI’s With Derivatives As Underlying.

 

19 July, 2017

 

 

The Securities & Exchange Board of India (“SEBI”) vide its notification dated July 07, 2017 has prohibited the issuance of offshore derivate instruments (“ODI’s”) by Foreign Portfolio Investors (“FPI’s”) with derivatives as underlying, unless such derivative positions are for the purposes of hedging  equity shares held by such FPI, such positions being held on a one-on-one basis.

 

The circular further mandates that outstanding ODI’s which have been issued by FPI’s with derivatives as underlying and which are not for the purposes of hedging an equity position taken by the FPI shall to be mandatorily liquidated by the date of maturity of such instrument or by December 31, 2020, whichever is earlier.

 

For the issuance of any further ODI’s by FPI’s with derivatives as underlying, the ODI issuing FPI shall procure a certificate from its compliance officer (or an equivalent officer) certifying that the derivative position that has been taken is for the purposes of hedging any equity shares held by it. This certificate shall be filed with the monthly ODI reports to be filed by the FPI.

 

Definition of ODI

 

As per Section 2 (1) (j) of the SEBI (Foreign Portfolio Investors) Regulations, 2014 (“Regulations“) an “Offshore Derivative Instrument” means any “instrument, by whatever name called, which is issued overseas by an FPI against securities held by it that are listed or proposed to be listed on any recognised stock exchange in India, as its underlying”.

 

While participatory notes consist majority of the ODI’s issued by FPI’s, there are equity – linked notes, capped return note’s, participating return note’s, investment note’s and similar instruments also issued by FPI’s or their sub-accounts outside India against their underlying investments in India, which also qualify as ODI.

 

SEBI’s position

 

SEBI, in keeping with its long term position of reducing the issuance of opaque instruments by FPI’s and possible indirect purchase by p-notes by promoter entities, had issued a consultative paper on May 29, 2017 on “Streamlining the process of monitoring of Offshore Derivative Instruments (ODI’s)/ Participatory Notes”, which had proposed for the actions presently being undertaken through this Circular.

 

Based on the same, the Board of SEBI in its meeting dated June 21, 2017, had decided that (i) a regulatory fee of USD 1000 shall be levied on each ODI subscriber, which shall be collected and deposited by the ODI issuing FPI of such ODI subscriber, once every three years, starting from April 1, 2017 and had further decided on (ii) a prohibition on ODI’s from being issued against derivatives, except on those which are used for hedging purposes.

 

Analysis

 

An impact of such a move by SEBI will result in a reduction in issuance of instruments such as participatory notes based on derivatives. The prohibition stems from the difficulty SEBI has in tracking end beneficiaries of such instruments and the view that same could be used for ‘laundering’ of money.  Having said it, it is important that SEBI already has in place mechanisms to track beneficiaries of such instruments due to the fact that FPI’s are now required to report the details of all holders of ODI instruments.

 

As of July 11, 2017, FPI’s have filed a representation with SEBI requesting for additional time for squaring off the positions. SEBI has not issued any statements in relation to such plea.