In September 2019, India’s securities market regulator (Securities and Exchange Board of India or SEBI), enacted the SEBI (Foreign Portfolio Investors) Regulations 2019 (FPI Regulations). The FPI Regulations lay down the legal framework governing portfolio investments in India by foreign investors. They were enacted with the purpose of promoting foreign portfolio investments in India and easing the applicable requirements. However, the FPI Regulations are currently posing regulatory issues for funds interested in investing in Indian securities. 

As background, it is important to note that, under the FPI Regulations, an entity can register with SEBI as either a Category I FPI or a Category II FPI, the former being a more sought after registration due to tax benefits, lower KYC requirements and ability to deal in Offshore Derivative Investments (p-notes). For entities to be eligible for registration as a Category I FPI, the FPI Regulations place reliance on the jurisdiction of the applicants, facilitating applicants from Financial Action Task Force (FATF) member jurisdictions. Considering the major chunk of portfolio investment in India is routed through non-FATF countries such as Mauritius and Cayman Islands, the procurement of a Category I FPI registration has been a cause of concern for applicants from non-FATF jurisdictions. 

Regulation 5(a)(v) of the FPI Regulations, in an attempt to accommodate applicants from non-FATF jurisdictions, provides that an entity from a non-FATF member country is eligible for registration as a Category I FPI by relying on its investment manager, if such investment manager is (a) from an FATF member country and (b) registered as a Category I FPI. More recently, the Government of India, recognizing the need to attract investors from non-FATF member countries, provided further relaxation (here and here) to Mauritius under Regulation 5(a)(iv) of the FPI Regulations, pursuant to which an unregulated fund from Mauritius can secure registration as a Category I FPI if its investment manager is appropriately regulated and registered as a Category I FPI. However, a regulated fund from Mauritius does not need to rely on its investment manager.

In both the above cases, the applicant from a non-FATF jurisdiction would have to rely on the investment manager to seek registration as a Category I FPI. SEBI requires such an investment manager to provide an undertaking on behalf of the applicant stating, inter alia, that the investment manager would be responsible for ‘any investment activity’ and ‘liable for all acts of commission and omission’ of the applicant fund. 

Would an investment manager of an entity be willing to take on the responsibility and sign such an undertaking? Such a requirement would make the investment manager liable not only for the acts of the applicant under the FPI Regulations but also any ‘investment activity undertaken’ by the applicant. SEBI would essentially have the power to proceed against the investment manager even if the applicant violates provisions of other regulations under the SEBI regime. This would especially pose an issue where the investment manager performs a non-discretionary role for the applicant. 

Investment managers owe their clients a duty of care, a duty to exercise due skill and contractual duties under the investment management agreement. The investment management agreement between the applicant and the investment manager would usually not cover such a wide scope of liability of the investment manager, and it is common practice for the client to ensure regulatory compliances. 

In the current market, investment managers have been reluctant to provide such an undertaking on behalf of their client. The wording of the undertaking required from the investment manager, on paper, makes them liable for all investment activity of the fund. Even in the best case scenario where SEBI may choose not to take action against the investment manager and proceed against the applicant in case of non-compliance, as it has done in the past, this undertaking essentially poses difficulty for applicants from countries such as Mauritius and Cayman Islands seeking investment in Indian securities. Since this is a regulatory requirement, there is no scope for negotiation between the applicant and the investment manager. The only way to attract more investment in India from these jurisdictions would be for SEBI to consider relaxing the requirement of such a declaration altogether. 

Nirmit Agrawal is an Associate at a leading law firm based in Mumbai.