Shruti RajanPartner
Khyati GoelSenior Associate
Rebecca CardosoAssociate
Key Developments
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Regulated entities and their intermediaries prohibited from associating with unregulated entities providing financial advice, including finfluencers
India’s stock market regulator, the Securities and Exchange Board of India (SEBI), has recently approved a new framework to protect investors from unregulated financial advice. In its board meeting on 27 June 2024, SEBI decided to prohibit SEBI-regulated entities and their agents from associating with any unregulated entities providing advice or recommendations or making any claim of return or performance concerning securities.
The exceptions to this prohibition are:
- individuals exclusively engaged in providing investor education and not providing advice or recommendation or promising returns, and
- specified digital platforms that have safeguards to remedy or take action against any misadvise to SEBI’s satisfaction.
This move follows a consultation paper floated by SEBI last August expressing concerns about unregistered entities or ‘finfluencers’ enticing their followers to purchase products, services, or securities in return for undisclosed compensation from platforms or producers. The consultation paper proposed to restrict the association of SEBI registered intermediaries/regulated entities with unregistered ‘finfluencers’ to curb the flow of such compensation. Since then, the regulator has also come down heavily on ‘finfluencers’ for providing unregulated financial advice. SEBI’s current proposal is broad and generic, seemingly covering any form of association between regulated and unregulated entities. The issuance of the official notification setting out and implementing this framework is awaited to understand the precise modalities.
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Stockbrokers mandated to establish institutional mechanisms for fraud prevention
In a welcome move, SEBI has established an institutional mechanism for fraud prevention and detection. On 27 June 2024, it notified the inclusion of a new chapter to the SEBI (Stock Brokers) Regulations, 1992, to place certain obligations and compliances on stock brokers and their employees. While increasing the compliance burden, this move looks to strengthen market integrity and boost investors’ confidence by ensuring that robust systems are maintained to detect and prevent fraud and market abuse.
The key takeaways from the new chapter are:
- The key managerial personnel (KMP) and senior management of the stock broker must implement adequate systems for surveillance of trading activities and internal control systems to prevent, detect and report potential fraud.
- The stockbroker must put in place policies and procedures relating to the surveillance systems and internal controls, define the roles and responsibilities of its employees, and the corrective actions to be taken. These must be reviewed and updated periodically by the board of directors of the stock broker.
- The stock broker must submit to stock exchanges, on a half-yearly basis, a summary analysis and action taken report on instances of suspicious activity, fraud, and market abuse.
- The stock broker must establish, implement, and maintain a whistle-blower policy that provides a confidential channel for employees and other shareholders to raise concerns about suspected fraudulent, unfair, or unethical practices, violations of regulatory or legal requirements, or governance vulnerability and ensures the protection of whistleblowers.
To ensure smooth adoption, compliance with the new obligations and implementation of mechanisms will be enforced in a risk-based, staggered manner based on the size of the stock brokers. The effective date of implementation for different stock brokers is as follows:
Size of Unique Client Codes (UCC) Date of Implementation More than 50,000 UCC 1 January 2025 2,001 to 50,000 UCC 1 April 2025 Upto 2,000 UCC 1 April 2026 For qualified stock brokers, the effective date will be 1 August 2024, regardless of the number of UCCs.
The Broker’s Industry Standards Forum has been tasked with formulating standards for the implementation of the obligations and mechanisms, including operational modalities, in consultation with SEBI.
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Introduction of streamlined disclosure regime for material changes applicable to foreign portfolio investors
On 5 June 2024, SEBI operationalised a new disclosure framework providing relaxed timelines for Foreign Portfolio Investors (FPI) to report material changes in information to their designated depository participants (DPP). Earlier, FPIs had to disclose all material changes within seven working days of the material change.
This move follows a consultation paper floated in February proposing to relax the timelines for disclosure in an attempt to relieve the compliance burden faced by FPIs in collecting supporting documents and making timely disclosures. It was observed that gathering information from entities spread across various jurisdictions was practically challenging. (To read our detailed update on the consultation paper, click here).
The new framework categorises material change into two buckets - Type I and Type II.
Type I material changes are critical changes that would render the FPI ineligible to invest in India.1 These include:
- change of jurisdiction,
- change of name due to an acquisition or merger/demerger or restructuring,
- change in ownership or control, or
- previously submitted information to SEBI or the DDP found to be false or misleading.
Type II material changes are simply those other than Type I material changes.
Under the new framework, Type I material changes will continue to be informed by FPIs to their DDP and/or SEBI within seven working days. However, supporting documents may now be provided within 30 days of the change. Type II material changes must be informed along with supporting documents within 30 days of the change.
Given the broad language provided in the framework, there remains an ambiguity in categorising changes as Type I or Type II. It remains to be seen how SEBI and the DDPs develop market practices on this classification.
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SEBI permits up to 100% NRI contribution for foreign portfolio investors based in International Financial Services Centre to increase the inflow of foreign investment
On 27 June 2024, SEBI issued a circular citing an amendment to the SEBI (Foreign Portfolio Investors) Regulations, 2019 (FPI Regulations), which allows up to 100% aggregate contribution by Non-Resident Indians (NRI), Overseas Citizens of India (OCI), and Resident Indians (RI) in the corpus of FPIs based in the International Financial Services Centre (IFSC) and regulated by the IFSC Authority (IFSCA). This regulatory shift is likely to open new avenues for investment and increase foreign investment inflows.
The enhanced flexibility is seen as a strategic response to the longstanding demand for greater participation of NRIs and OCIs in the Indian securities market. Under the new rules, FPIs must submit a declaration to their DDP at registration if they intend to have 50% or more of their corpus contributed by NRIs, OCIs, and RIs. Existing FPIs have a six-month window to comply with this requirement. However, the contribution of a single NRI, OCI, or RI must be less than 25% of the total FPI corpus, and the combined contribution from NRIs, OCIs, and RIs must be less than 50% of the total FPI corpus.
SEBI has imposed certain Know Your Customer requirements on such NRIs and OCIs without specifying an investment threshold. FPIs will be required to submit copies of PAN (or other documents specified by SEBI) for all their NRI, OCI, and RI investors, along with details of their economic interests in the FPI, to the DDP. If an individual lacks a PAN, the FPI must submit a suitable declaration with prescribed identity documents, such as an Indian passport, OCI card, or Aadhaar. Similar disclosures are required for indirect holdings in the FPI through non-individual entities primarily funded, owned, or controlled by NRI, OCI, or RI individuals. Further, FPIs set up in IFSC must satisfy certain conditions such as pooling of all contributions by such investors into one investment vehicle, all investors having pari-passu and pro-rata rights in the fund, and complying with several diversification requirements.
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Reserve Bank of India mandates compounding for issuance of partly paid-up units by alternative investment funds prior to 14 March 2024
On 14 March 2024, the Non-debt Instruments Rules were amended to enable the issuance of partly paid units to persons resident outside India by investment vehicles such as Alternative Investment Funds (AIF). This provides more flexible investment options for foreign investors.
Expanding the benefit of this facility, the Reserve Bank of India (RBI) has now regularised previous issuances of partly paid units by AIFs to non-residents from before the amendment. To facilitate this process, a compounding mechanism has been instituted under the Foreign Exchange Management Act, 1999. However, before approaching the RBI for compounding, authorised dealer banks must ensure that necessary administrative actions, including the reporting of such issuances by AIFs to RBI through the Foreign Investment Reporting and Management System (FIRMS) Portal and issuing of conditional acknowledgments for such reporting, are completed.
This initiative underscores RBI’s commitment to strengthening the regulatory framework governing foreign investments in India while fostering an attractive environment for foreign investors.
Over the next quarter, a boost in participation from foreign investors is expected, given the focus of both SEBI and RBI on encouraging the participation of non-residents in the Indian securities market. The other proposals contemplated by SEBI in its board meeting in June, such as exempting certain FPIs from making additional disclosures and the cybersecurity and cyber resilience framework for intermediaries, are also likely to be operationalised soon. The spike in retail investor participation in the futures and options segment may also result in heightened regulatory scrutiny and potential curbs or disincentives on trading in this segment, given the government’s concern about the risk it poses to retail investors.
[1]That is, ineligible for registration or making fresh purchase of securities, or would require the FPI to seek fresh registration, or would impact any privileges or exemptions granted to the FPI.
