India: SEBI Closes Doors On Previously Eligible Subscribers To Offshore Derivative Instruments

Last Updated: 11 July 2016
Article by Nandini Pathak, Richie Sancheti and Kishore Joshi
  • Under the FPI Regulations, ODIs can be issued only to regulated entities. However, under the erstwhile FII Regulations, unregulated 'broad-based' funds with appropriately regulated managers were also eligible to subscribe to ODIs.
  • The FPI Regulations had grandfathered all ODI subscribers who have subscribed to ODIs under the FII Regulations (prior to the commencement of the FPI Regulations). SEBI's FPI FAQs permitted such 'Grandfathered Clients' to continue rolling their existing ODI positions and also for taking fresh positions.
  • However, SEBI has now revised the FAQs to revoke this position available to Grandfathered Clients for renewing existing ODI positions or entering into fresh ODI positions effective from August 01, 2016. . It now states that (a) fresh ODIs can be issued to those entities which comply with SEBI circulars and FPI Regulations; and (b) Grandfathered Clients who are otherwise not eligible to now subscribe to ODIs, cannot take fresh positions or renew the old positions.


The Securities and Exchange Board of India ("SEBI") has been taking measures to tighten the norms for subscription to offshore derivative instruments ("ODIs") under the Securities and Exchange Board of India (Foreign Portfolio Investors) Regulations, 2014 ("FPI Regulations"). Recently, SEBI issued a circular harmonizing the systems and procedures adopted by ODI issuers to comply with the FPI Regulations by aligning the KYC/AML norms for client due diligence and imposition additional reporting and review requirements.1

In continuation of its intent to tighten the ODI subscription norms, SEBI has now decided to discontinue the availability of grandfathering to all entities which were registered as clients eligible to subscribe to and hold ODIs issued under the FII Regulations, including entities which were registered but did not have any positions as on January 07, 2014 (i.e. before commencement of the FPI Regulations) (the "Grandfathered Clients") from renewing existing ODI positions and taking fresh ODI positions. SEBI has introduced this change on June 29, 2016 by way of a circular2, giving clarifications on FAQ 70 and FAQ 71 of the SEBI Frequently Asked Questions on the FPI Regulations (the "Circular").

ODIs such as p-notes and other classes of over-the-counter derivatives allow the subscriber a streamlined basis for accessing several markets while dealing with very limited number of counterparties. Despite these changes, the ODI route would be preferred over direct investment as a foreign portfolio investor ("FPI"), as the latter comes with higher costs and administrative overheads including registration with SEBI, engaging a custodian and filing tax returns in India.

Immediate Implications

As per the Circular, only those Grandfathered Clients, who comply with Regulation 22 of the FPI Regulations (i.e. funds which are 'appropriately regulated') and the SEBI circular dated November 24, 2014 (CIR/IMD/FIIC/20/2014) (the "November 2014 Circular"), will be eligible to renew their existing ODI positions and take fresh ODI positions. However, the Grandfathered Clients, who do not fulfil these conditions ("Unregulated Grandfathered Clients"), can only continue to hold their existing positions till the date of expiry of such positions or till December 31, 2020, whichever is earlier.

While the Circular states that all ODI positions of Grandfathered Clients will be allowed the benefit of grandfathering until the earlier of the date of expiry of the ODI positions or December, 2020, it is important to note that Regulation 22 (4) of the FPI Regulations allows the ODI positions of Grandfathered Clients to continue until the date of their expiry without any hard stop limit. SEBI should clarify that Regulation 22 (4) of the FPI Regulations has been amended by the Circular in order to bring harmony among the FPI Regulations and the revised understanding on grandfathering.

The Circular will come into effect from August 01, 2016. Accordingly, the Grandfathered Clients have been given a month take measures to ensure continued access by complying with Regulation 22 of the FPI Regulations and November 2014 Circular. Contrary to this deadline prescribed by the SEBI, we understand that various ODI issuers in the market are rejecting Unregulated Grandfathered Clients from taking fresh positions from July 01, 2016 itself.

What was the benefit of grandfathering?

Regulation 22 of the FPI Regulations provides that Category I FPIs and Category II FPIs (which are directly regulated by an appropriate foreign regulatory authority3) are permitted to issue, subscribe and otherwise deal in ODIs. However, those Category II FPIs which are not directly regulated (which are classified as Category II FPI by virtue of their investment manager being appropriately regulated) and all Category III FPIs are not permitted to issue, subscribe or deal in ODIs.

Under the erstwhile SEBI (Foreign Institutional Investors) Regulations, 1995 (the "FII Regulations"), broad based 'unregulated' funds which were managed by appropriately regulated person were eligible to hold ODIs. The FPI Regulations (prospectively) removed unregulated funds as potential holders of ODIs because SEBI preferred such unregulated funds to use the format of direct participation (as FPIs), instead of indirect participation through ODIs. However, SEBI's earlier clarifications in FAQs 70 and 71 (prior to the introduction of the Circular) allowed all Grandfathered Clients to continue dealing in ODIs under the FPI Regulations despite being 'unregulated' funds (which were managed by appropriately regulated person).

Further, under the November 2014 Circular, SEBI had aligned the conditions for subscription of ODIs to those applicable to registration as an FPI under the FPI Regulations, particularly to meet certain eligibility criteria mentioned under regulation 4 of the FPI Regulations (which deals with eligibility criteria for an applicant to obtain registration as an FPI) in addition to meeting the eligibility criteria mentioned under regulation 22 of the FPI Regulations. Accordingly, ODIs can now only be issued to those persons who (a) are regulated by an 'appropriate foreign regulatory authority'; (b) are not resident of a jurisdiction that has been identified by Financial Action Task Force ("FATF") as having strategic Anti-Money Laundering deficiencies; (c) do not have 'opaque' structures (i.e. protected cell companies ("PCCs") / segregated portfolio companies ("SPCs") or equivalent structural alternatives); and (d) comply with 'know your client' norms. Our analysis of the November 2014 Circular can be accessed here

Accordingly, all Grandfathered Clients are required to ensure that they are not the resident of a jurisdiction that has been identified by FATF as having strategic Anti-Money Laundering deficiencies; do not have opaque structures such as PCCs/SPCs and comply with the KYC norms (in accordance with the SEBI Circular dated June 10, 2016, CIR/IMD/FPI&C/59/2016).

What next

SEBI has now disallowed unregulated funds (even if managed by a regulated entity) from holding ODIs under the FPI Regulations because it would encourage direct participation by such unregulated entities as FPIs. However, given the lack of guidance on which entities can be considered as "regulated by an appropriately foreign regulatory authority" for the purposes of subscription to ODIs under the FPI Regulations, the revocation of grandfathering will pose new difficulties and introduce more disparities among different ODI issuers.

In some jurisdictions (such as the Cayman Islands), the registration of a fund with a regulatory authority (the Cayman Islands Monetary Authority) could be considered as being "regulated with an appropriate foreign regulatory authority"; whereas, other jurisdictions (such as the United States) allow exemptions from registration with the federal regulator, i.e. the U.S. Securities and Exchange Commission ("SEC") which would put many U.S. based hedge funds not required to be registered with the SEC (even though pooling vehicles may be regulated by state level regulators) at a worse off position, though such funds are, in some way, supervised by the SEC.

The removal of the 'grandfathering' provisions would immensely affect the operations for several operators as the Unregulated Grandfathered Clients happen to be the majority investors through the ODI route. As such, hedge funds will not be permitted to renew or extend the existing ODI positions after August 01, 2016, and certain restructuring exercises will have to be undertaken for the beneficial owners to continue holding ODI positions.

Some of the Unregulated Grandfathered Clients, who are currently holding ODI positions, have master-feeder structures. One option for such hedge funds is that they continue to hold the current positions, held through the master funds, till the date of its expiry, and buy new positions through the feeder funds provided, of course, they are appropriately regulated.

If, for some reasons, the feeder funds do not want to hold the ODI positions, they can seek registration from the SEBI as Category II FPI (assuming that such feeder funds are appropriately regulated) and hold the Indian securities directly, by acquiring them from the ODI Issuers.

We, as a legal advisory firm, are trying to explore a possibility of making a representation to the SEBI, with the help of overseas associations, and try to impress upon SEBI that so far as the hedge funds are managed by the appropriately regulated Investment Managers / Investment Advisors ("Managers"), and that the said Managers give an undertaking to the SEBI that they will be solely responsible for the due compliance of all the conditions and rules, as prescribed by the SEBI from time to time, such unregulated hedge funds should be allowed to participate in the ODIs. To ensure effective monitoring, SEBI can insist that such Managers should be registered with the SEBI as Category II FPIs, till the time they act as Managers to such unregulated hedge funds. Further, all the disclosure filings prescribed by the SEBI in respect of ODI investments should be done by the Managers.

Several institutional swap dealers dealing in Indian products were already in-compliance with most of the revised directives, since they have been engaging with SEBI and incorporating their feedback in their ODI issuance program. P-Notes and other classes of over-the-counter (OTC) derivatives allow the subscriber a streamlined basis for accessing several markets while dealing with very limited number of counterparties. Authorities have long-feared that keeping private the identity of the eventual beneficial owners has prompted the use of these derivative products for money laundering and round-tripping. With these norms now a part of the regulatory framework, the Indian regulators should be comfortable with both the forms of market access.


1. CIR/IMD/FPI&C/59/2016 dated June 10, 2016

2. CIR/IMD/FPI&C/61/2016 dated June 29, 2016

3. Reference may be made to Explanation 1 to Regulation 5 of the FPI Regulations where it is provided that an applicant (seeking FPI registration) shall be considered to be "appropriately regulated" if it is regulated or supervised by the securities market regulator or the banking regulator of the concerned jurisdiction, in the same capacity in which it proposes to make investments in India.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on

Click to Login as an existing user or Register so you can print this article.

Nandini Pathak
Richie Sancheti
In association with
Related Topics
Related Articles
Up-coming Events Search
Font Size:
Mondaq on Twitter
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
Email Address
Company Name
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of

To Use you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.


The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.


Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions