The ‘rounding tripping’ – a euphemism for the coming back, in the garb of foreign capital, of Indian money which left our shores in a clandestine manner – is a phenomenon that characterized wholly the first decade of the present century, persisted on a somewhat reduced scale during the first half of current decade [2011-2015] and is more or less fizzling out during the second half.
The dubious practice proliferated when there was little oversight on money leaving the country and there were tax haven jurisdictions such as Mauritius, Singapore etc ever ready to attract it. The shell companies – mostly owned by persons to whom the money belonged set up in those countries – would then, invest in India. Such inflows also enjoyed preferential tax treatment here, courtesy tailor made tax treaties India had with those countries.
For instance, under the then India-Mauritius double taxation avoidance agreement [DTAA], India granted tax exemption on capital gains made by investors resident in Mauritius [the definition of ‘resident’ was so generous that even post-box/shell companies were eligible] from sale of shares of Indian companies. Since, no capital gain tax was levied in Mauritius either, the income accruing from such gains escaped tax in both countries. The same dispensation applied to investors from Singapore.
The investment from these countries was made mostly in offshore derivative instruments [ODIs] or Participatory notes [P-notes]. P-notes are instruments issued by foreign portfolio investors [FPIs] registered with Securities and Exchange Board of India [SEBI] against Indian stocks to overseas subscribers who themselves do not wish to get registered.
Though, the stated rationale for allowing investment through this route was to avoid hassles of extensive documentation/compliance that go with registration, its real intent was to offer a veil of secrecy to those [round trippers] who were making such investment. No wonder, investment via P-notes reached a crescendo in 2007 when these were 56% of total portfolio inflows.
Since 2011, SEBI initiated a series of steps which on the one hand, simplified and rationalized process of direct registration and on the other, tightened norms for investment via P-notes. It started exercising greater regulatory oversight over the FPIs issuing such instruments. That did not help much as the root cause viz. veil of secrecy surrounding these instruments remained un-addressed.
Unlike domestic investors who are subject to onerous Indian KYC [know your customer] norms, FPIs and subscribers of P-notes had only to comply with KYC norms of the jurisdiction where these entities are located. The latter were very liberal.
The SEBI has addressed this anomaly by subjecting foreign investors to the same KYC norms as applicable to domestic investors. Their KYC status has to be reviewed annually. The FPIs are required to report information regarding their investment on monthly basis. The P-notes status has to be updated every six months. The issuer should immediately inform the financial intelligence unit [FIU] in finance ministry when unusually high volumes of P-notes change hands. P-notes can’t be issued to resident Indians, non-resident Indians [NRIs] or persons of Indian origin [PIOs].
The above requirements have sought to lift the veil of secrecy surrounding foreign investment coming via FPI and bring clarity about the beneficial owners.
Meanwhile, a committee under HR Khan, ex-governor, Reserve Bank of India [RBI] on easing FPI norms has come up with recommendations which if accepted could put a spoke in the wheel. It has recommended allowing private banks to invest on behalf of their clients through individual accounts. This will enable offshore investors, who don’t wish to be registered with SEBI, to invest in India through any foreign bank that is a SEBI-registered FPI.
Earlier, private banks were allowed to do only proprietary trades [trading done using an entity’s own money]. In 2017, SEBI allowed them to invest on behalf of their clients. However, to prevent any misuse of the route, the regulator asked them to maintain a common portfolio. This did not enthuse investors as the banks didn’t have the liberty to create customized portfolio for their clients.
The committee’s recommendation gives the much needed flexibility to private banks handle customized portfolio through individual accounts. However, what raises many eyebrows is another suggestion that investors coming through private banks need only comply with the KYC norms of their home country subject to the FPI being from a FATF [Financial Action Task Force] member country. Further, the KYC information stays with the global custodians only.
The KYC norms of the country where the FPIs are located do not necessarily require disclosure of ultimate beneficiary. So, the banks need only give the information of the front entity that has invested thus concealing the actual beneficiary. In other words, the market regulator won’t get to know the details about the persons/entities who own the funds coming to India.
The panel has also recommended that “in order to curb any misuse, custodians should submit the ownership details of their clients to SEBI once in every three months”. This is of no use as for ascertaining ‘from where the money originated’ [a prerequisite for figuring out ‘round tripping’], it is important to know the KYC of the investor, not how much he/she owns and in which Indian stock.
A major flaw that investment via P-note earlier suffered from was the veil of secrecy surrounding such investment as the investors were required to comply with KYC norms of their home country. The secrecy veil was removed with revision in norms requiring them to comply with Indian KYC norms. The further requirement of reviewing KYC status annually and seeking investment details on a monthly basis has made things more transparent.
Having come that far, the recommendation of committee to now let investors come through private banks even while hiding their identity will tantamount to resurrecting the erstwhile P-note under a new incarnation. It is a surreptitious attempt to create a fertile ground for encouraging ‘round tripping’. The government should reject it with the contempt it deserves.