India's SEBI Proposes Stricter Rules for Offshore Derivative Instruments

India's Securities and Exchange Board (SEBI) has unveiled a proposal to implement more stringent regulations for offshore derivative instruments (ODIs). The announcement, made on August 6, 2024, aims to enhance transparency and mitigate risks associated with these financial products.

ODIs are financial instruments that allow foreign investors to gain exposure to Indian markets without direct registration in the country. These instruments have been subject to increasing scrutiny by SEBI since the early 2000s, with the regulator gradually tightening controls to address concerns about market integrity and investor protection.

The proposed changes include:

• Stricter disclosure requirements for ODI holders
• Limitations on underlying exposures to cash equity and debt only
• Application of concentrated holdings disclosure rules to foreign ODI investors
• Mandatory liquidation within 180 days for non-compliant subscribers

SEBI has suggested that ODI subscribers disclose their investors if more than 50% of their assets are invested in a single Indian corporate group. This move aligns with the regulator's focus on enhancing market transparency and reducing potential risks associated with concentrated holdings.

The proposal also seeks to discontinue the practice of using derivatives as hedges for ODIs. Existing ODIs with derivative hedges would need to be redeemed within one year if the proposal is implemented. SEBI expressed concerns about multiple levels of leverage when ODIs are hedged using derivatives, noting that this practice shifts leverage from overseas to the Indian financial ecosystem.

These proposed changes reflect SEBI's ongoing efforts to strengthen the regulatory framework for foreign investments in India. The regulator, established in 1992, has been instrumental in shaping the country's securities market regulations and has consistently worked to balance market growth with investor protection.

"The proposed changes aim to address concerns regarding multiple levels of leverage and enhance transparency in offshore derivative instruments."

It's worth noting that the use of ODIs in Indian markets has declined significantly over the years. In 2007, ODIs accounted for about 55% of total Foreign Portfolio Investor (FPI) assets, but by 2023, this figure had dropped to less than 10% due to regulatory tightening.

The public has until August 27, 2024, to submit comments on these proposals. As India's stock market capitalization reached $3.5 trillion in 2023, making it the 5th largest globally, these regulatory changes could have significant implications for both domestic and international investors.

SEBI's proposal underscores the regulator's commitment to leveraging technology and enhancing regulatory oversight to ensure market integrity and investor protection in India's rapidly evolving financial landscape.