12/14/2014

INDIANCORPORATELAW:TighterRestrictionsonOffshoreDerivativeInstruments
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Tuesday,November25,2014

TighterRestrictionsonOffshoreDerivativeInstruments
Theissueofoffshorederivativeinstruments(ODIs)suchasparticipatorynotes(PNs)havebeenthe
subjectmatterofregulatorycontroversyforsometimenow.Theseareinstrumentsissuedbyforeign
institutionalinvestors(FIIs)(nowforeignportfolioinvestors(FPIs))toinvestorsoverseasthatmimic
therisksandrewardsonunderlyingsecuritiesheldbytheFIIs/FPIsinIndiancompanies.These
instrumentshavecauseddifficultiesfromaregulatorystandpointastheyhavebeenissuedoverseas
withinlimitationsonthelongarmjurisdictionsofSEBI.Theseissueshavebeendiscussedina
previouspaper.
Yesterday,SEBIissuedacircularthatimposessignificantrestrictionsontheissueofODIsbyFPIs.
InameasureintendedtoaligntheapplicableeligibilityandinvestmentnormsbetweentheFPIregime
andtheODIroute,SEBIhasprescribedthatanFPIcanissueODIsonlytosubscribersthatmeetthe
eligibilityrequirementsundertheSEBI(ForeignPortfolioInvestor)Regulations,2014.Theseeligibility
criteriaincludethatfactthattheapplicantisresidentinacountrywhosesecuritiesmarketscomply
withIOSCOrequirements,orabankfallswithintheframeworkofBIS.Itexcludesinvestorsfrom
countriesthathavebeenshortlistedforfailingtocomplywithtransparencyrequirements.Furthermore,
FPIsarenotallowedtoissueODIstosubscribersthathaveopaquestructuresasdefinedintheFPI
Regulations.
TheabovecirculareffectivelycurbsafairlysignificantmarketforODIs.Investorsfindreasontoinvest
inODIsonlyiftheyotherwisedonotwishtoregisterthemselvesasFPIsandinvestdirectlyintothe
Indianmarkets.OneofthereasonswhyODIsareattractiveisbecauseoftherelativeopacityitoffers.
TheriskaccompanyingODIsisthatitmaybemisusedformoneylaunderingandforroundtrippingby
Indianinvestors.SEBIscirculareffectivelycurbssuchactivityandmakestheODIprocessmore
transparentasonlyinvestorsthatqualifytoregisterasFPIswouldbeentitledtotakeupODIs.In
otherwords,SEBIhasinonefellswoopeliminatedtheregulatoryarbitragethatwasavailableto
foreigninvestorswhowishtoremainopaque.Thisisindeedawelcomemovefromtheperspectiveof
transparency.ItalsoputsasignificantonusonFPIstoensuretheyissueODIsonlytoqualifying
investors,whichmightmeantighteningoftheKYCnorms.

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JayantThakur
MihirNaniwadekar
ShantanuNaravane
SomasekharSundaresan
UmakanthVarottil
V.Niranjan

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Therehasbeensometighteningonotherincidentalaspectsaswell.Forinstance,ODIswillbe
counted(intermsofbeneficialownership)fordeterminingthemaximumlimitsforinvestmentbyFPIs
inIndiancompanies.Itwouldnotbepossibletocircumventtheinvestmentlimitsthroughindirect
routessuchasparticipationinODIs.
ThismeasuremightlikelyresultinasignificantreductionintheuseoftheODIstructure.Thisis
relevantgiventhesubstantialincreaseinODIactivityinrecenttimes.Whilethismayaffect
investmentflowsintheshortrun,SEBIsapproachisnecessaryandtimelyfromaregulatory
perspective.

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PostedbyUmakanthVarottilat9:15AM
Labels:CapitalMarkets,ForeignInvestment,SEBI,SecuritiesRegulation

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3comments:
Anonymoussaid...

Enteryouremailaddress:

"ODIswillnotbecounted(intermsofbeneficialownership)fordeterminingthemaximum
limitsforinvestmentbyFPIsinIndiancompanies"

Subscribe
CanyoupleaseclarifyThoughtthiswastheotherwayround.

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Thanks!

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12/14/2014

INDIANCORPORATELAW:TighterRestrictionsonOffshoreDerivativeInstruments
November26,2014at8:47PM

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UmakanthVarottilsaid...

AjayShah'sBlog

@Anonymous.Thanksforhighlightingthis.Yes,itshouldbetheotherwayround.Itwasa
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BusinessLawProfBlog

November27,2014at2:57AM

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ShekharSinghsaid...

CorporateLawandGovernance

ItwasagoodArticlebuttherewasNOCLARITYabouttheconflictoftheCompaniesAct,
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December12,2014at3:16PM

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