Foreign Portfolio Investors registered under the SEBI (FPI) Regulations, 2014, are permitted to issue offshore derivative instruments (ODIs) and participatory notes (P-Notes) to overseas investors who seek to invest in the Indian securities market without registering as an FPI. While the issuance of ODIs is governed by stringent norms within regulation 22 of the FPI Regulations, SEBI has constantly been issuing circulars to further streamline and tighten the conditions for issuance and reporting of ODIs by FPIs registered with SEBI.

Pursuant to a consultation paper issued in May 2017, SEBI, through its circular dated July 07, 2017, has issued further guidelines to enhance the transparency in the process of issuance and monitoring of ODIs. The circular now prohibits FPIs from issuing ODIs with derivative as the underlying security. The only exception to this is in cases where the derivative positions are taken by the ODI issuing FPI for hedging the equity shares held by it, on a one to one basis. It has been clarified that ‘hedging of equity shares’ shall mean taking a one-to-one position in only those derivatives which have the same underlying as the equity share.

Where existing ODIs have derivatives as the underlying but where such derivative position has not been taken for the purpose of hedging of equity shares, such ODIs have to be liquidated latest by the date of maturity of the ODI or by December 31, 2020, whichever is earlier. For the issuance of new ODIs against derivatives, the concerned FPI shall have to provide a certificate stating that ODIs are only issued against derivative positions taken by the FPI for hedging the equity shares.

In the consultation paper issued in May 2017, SEBI had also proposed that, for a period of every three years, it would levy a regulatory fees of US$ 1,000 on each ODI issuing FPI for each and every ODI subscriber coming through such FPI. It would seem that SEBI has decided against introducing such regulatory fee.

SEBI’s reforms relating to FPIs over the past couple of years has simplified the mechanism for an investor to directly invest by registering as an FPI and greatly disincentivized investment through the ODI route. These measures have primarily been undertaken due to concerns regarding uncertainty of the ultimate beneficial ownership of the ODIs and they have successfully reduced the overall value of outstanding ODIs. However, they are bound to have an adverse impact on the liquidity in the derivatives market.