Close on the heels of revising the India-Mauritius DTAA [double taxation avoidance agreement] which will completely eliminate tax arbitrage opportunities from April, 2019 and hence, the incentive for routing of Indian money through that tax haven jurisdiction, Modi – government has taken the fight against black money and rounding tripping to the next higher level.
The Securities and Exchange Board of India [SEBI] – national regulator for investment in shares and other securities issued by Indian companies – has drastically amended the norms for foreign investment via offshore derivative instruments [ODIs] or Participatory notes/P-notes [as these are known in common parlance] which have been used a major conduit for reverse flow of Indian black money as well as other forms of dubious capital flows viz., drug trafficking etc.
ODIs/P-notes are instruments issued by foreign portfolio investors [FPIs] registered with SEBI against Indian stocks to overseas entities/subscribers who themselves do not wish to get registered with the national regulator. Prima facie, the rationale for allowing investment through this route is to help them avoid the hassles of extensive documentation and compliance [that go with registration] and yet, participate in India’s growth story.
Unambiguously, this option has been far more attractive to foreign investors than direct investment in Indian stocks. As a result, huge amount of funds came to India via P-notes reaching a crescendo in 2007 when these accounted for more than 50% of total FPIs. But, these also raised doubt as to whether a major slice of these funds were nothing but Indian black money stashed abroad finding its way back to India?
SEBI initiated a series of steps since 2011 which on the one hand, simplified and rationalized process of registration of FPIs and on the other, tightened norms for investment via ODIs/P-notes. The latter involved greater regulatory oversight over the institutions issuing such instruments. As a consequence, their share in total inflows has declined to around 10% currently [March, 2016] yet, it continues to be substantial at around Rs 225,000 crores.
True, greater regulatory oversight over the issuers has helped reduce gravity of the problem but, its genesis remains un-addressed. And, that has to do with the identity of the beneficiaries of ODIs/P-notes. Unlike domestic investors who are subject to onerous Indian KYC [Know Your Customer] norms, issuers and subscribers of ODIs/P-notes have only to comply with the KYC and money laundering norms of the country/jurisdiction where these entities are located. This is not just discriminatory but also bizzare!
The impact of actions by these entities [increase in their level of investment or sudden withdrawal] is inevitably felt on Indian market and economy at large. Yet, exonerating them from Indian KYC [compliance with norms of country of their location which any way are weak and liberal are irrelevant and of little use] smacked of an attempt by successive political establishments thus far, to allow the ultimate beneficiaries hide their identity.
The Indian authorities not being able to know their identity/whereabouts and activities [source of their fund generation and pattern of investment] was bad enough. What made the scenario even more gruesome was that even the issuer of ODIs/P-notes [read FPIs] did not know their identity. This is because when the original subscriber sold to another person, he was not even required to inform the issuers about the transaction forget taking latter’s prior concurrence.
This led to an anomalous situation whereby an Indian company won’t even know its share holding pattern viz., who owns how much? Under extant dispensation regarding foreign investment, an individual cannot own more than 10% share in company whereas, the holding of an institution/corporate entity cannot exceed 25%. A sizeable portion of equity resting with investors whose identity was not known seriously undermineed the effectiveness of this policy.
Such a scenario could be pregnant with dangerous possibilities. For instance, money launderer could end up having a controlling stake in an Indian company. What if persons/entities holding sizeable shares funded this with money garnered from all sorts of illicit activities such as terrorism, extortion money, smuggling, drug trafficking etc. All of this could have serious security implications.
In this backdrop, it was only apt that SEBI has amended the norms to subject the subscribers of ODIs/P-notes to the same KYC/laundering norms as applicable to domestic investors. The issuers will also be required to report to Indian regulator information relating to their investment on real time basis. The original subscriber will be mandatorily required to seek prior approval of the issuer before selling the instrument to another person. The issuer/FPI will also be required to ‘immediately’ inform authorities in India as and when it suspects any dubious transaction or where unusually high volumes of P-notes have changed hands. In short, the amendments have sought to lift the veil of secrecy around these instruments, make investment via this route transparent and bring clarity about beneficial owners.
The revised norms will no doubt go a long way in discouraging money launderers who look for channels to give their illicit funds a semblance of legitimacy. But, the success of this will depend on the “alertness” of the regulator and “speed” with which it gets in to action mode to act against violators. If, SEBI does not act and merely sits on the information thus received from issuers, then the purpose of the entire exercise would be defeated.
The new dispensation is far from being a permanent remedy to the menace of ‘round tripping’ and flow of hot global capital. That would be possible only when the government prohibits investment via P-notes. SEBI chairman, UK Sinha has opined that henceforth a foreign investor would be prompted to invest directly in Indian stock instead of taking an indirect route. It would be a good idea to take this forward by completely shutting the P-notes window.
At present, under the dynamic leadership of a decisive prime minister, a “stable” and “predictable” policy regime in place and “ease of doing business” on top of government’s agenda, confidence in Indian economy is at its peak and foreign investors are looking at India with unprecedented interest. They are very much willing to invest directly and won’t need extra sops.
Modi should therefore crack the whip by saying “NO” to foreign investment via ODIs/P-notes.