SEBI

Conditions & Reporting Requirement for Offshore Derivative Instruments

The offshore derivative instruments or ODI are the investment vehicles that are used by the overseas investors for getting an exposure in Indian equities or equity derivatives. These types of investors generally contact with foreign institutional investors (FII) who are already registered with SEBI. The FII makes purchases on behalf of those investors and the related FIIs issue ODIs to them. As per Section 2(1) (j) of the FPI Regulations 2019, the offshore derivate instruments mean any instrument issued overseas by FPI against securities held by it that are listed or proposed to be listed on any recognised stock exchange in India. ODIs can only be issued to those persons who are regulated by an appropriate foreign regulatory authority and after complying with “Know Your Client” norms. To regulate offshore derivative instruments, the SEBI consolidates the conditions, KYC norms and reporting requirements. The present article will discuss such provisions in accordance with the master circular for FPI, DDP and eligible foreign investors.

Conditions for Issuance of ODIs

The condition for the issuance of Offshore Derivative Instruments are:

• The FPIs must not issue ODIs referencing derivatives. Further, no FPI must be allowed to hedge their ODIs with derivative positions on stock exchanges in India.
• The following is permitted through a separate FPI registration of an ODI issued under Category I:
  • Derivative positions that are taken on Stock Exchanges by the FPI for “hedging of Equity Shares” held by it in India on a one-to-one basis.
  • The FPI issuing ODI may hedge the Offshore Derivative Instruments referencing equity shares with equity shares in derivative positions in India in stock exchanges. However, these are subject to position limits of 5% of market-wide position limits for single stock derivatives. The permissible position limit for stock index derivatives is INR 100 crore or 5% open interest.
  • The FPI hedges its ODI by investing in its securities in India and is not allowed to take derivative positions through the same FPI registration. However, such FP is required to segregate its ODI and proprietary investments through separate FPI registration and such registration shall be in the name of FPI with “ODI” as a suffix under the same PAN. When the FPI requests such an addition, this addition will not be treated as a change in the name of the FPI and DDP may process this request and issue a new FPI registration certificate.
  • The FPI issuing ODI cannot co-mingle its non-derivative proprietary investments and ODI hedge investments with its propriety derivative investment or vice versa in the same FPI registration.

In order to better understand the ODIs reference and their allowance, the following table shall be referred to:

ODI reference	ODI issuers holding in India against the ODI	Allowed	Exception
Cash Equity or Debt Securities or any Permissible investment by FPI	Cash Equity or Debt Securities or any Permissible investment by FPI for the life of ODI	yes	None   However, Separate registration is required to undertake any proprietary derivative transactions by FPI issuing ODI.
Cash Equity	Cash equity on the date of writing the ODIs and then moving to derivative positions thereafter.	No	Can do so by separate FPI registration, subject to a 5% limit.
Cash equity	A derivative on the date of writing the ODI	No	None
Derivatives	Derivatives	No	Can do so through separate FPI registration, provided FPI is holding cash equity and has a future short position exactly against the cash equity in the same security.   FPI to retain the cash equity for the life of ODI.
Derivatives	Cash Equity	No	None

• The FPI is required to comply with the above requirements within 90 dyes from the date of publication of operating guidelines. The non-failure of compliance will lead to the non-issuance of any fresh derivative position. However, market transfer of assets or positions is allowed for FPIs intending to transfer assets or positions from one FPI account to another FPI.
• In order to determine whether a derivative instrument is an ODI or not, the threshold for trades shall be taken as 20% with non-priority indices. However, trades with underlying custom baskets would always be regarded as ODI if hedged onshore, irrespective of the percentage of Indian components hedged onshore in India.
• Synthetic short activities will continue to be prohibited for FPIs where the ODI are issued and has the effect of a short sale in the Indian securities.
• ODI issuer must ensure that it has collected documents and all the information for adjudging the relationship between the ODI subscriber and its investment manager from A FATF Country.
• The investment restrictions mentioned under Regulation 20 (7) of the SEBI (Foreign Portfolio Investor) Regulations 2019.

Know your Client (KYC) norms for ODI Subscribers

The KYC norms for Offshore Derivative Instruments subscribers are:

1. The FPIs issuing the ODI are required to maintain the KYC documents of the ODI subscribers at all times and further make them available to SEBI when demanded.

2. The FPIs issuing offshore derivative instruments shall identify & verify the beneficial owners of the ODI subscriber’s entities. The Beneficial owner and intermediate shareholder holding equal and above the threshold in the ODI subscribers need to be identified through a look-through basis. The FPI shall also continue to collect the identification document number of the beneficial owner of the ODI subscriber.

3. The name, country and percentage holding for an intermediate material shareholder or owner entities shall also be disclosed.

4. The KYC review should be done based on the risk criteria as determined below:

1. High-risk Offshore Derivative Instruments subscribers: Yearly Basis
2. Other subscribers: every 3 years.

5. The FPIs shall issue suspicious transaction reports with the Indian Financial Intelligence Unit.

6. The KYC documents that are required from the ODI subscribers are:

1. ODI subscriber: constitutive documents, Address proof, Board Resolution
2. Beneficial Owner of ODI subscriber: list, Identity proof, address proof
3. Senior Management ( Whole Time Directors/ partners/ Trustees etc.): List

Reporting of ODIs and Maintenance of Control systems

The provision for reporting requirements of Offshore Derivative Instruments and maintenance of control systems are:

1. Reporting of all transfer trails of ODIs: The details of the holder of Offshore Derivative Instruments must be reported to SEBI on a monthly basis. Further, ODI issuers must collect all the details of all the transfers of the ODIs issued by them and make them available to SEBI on demand. SEBI also decides that the monthly reports on ODIs shall include the intermediate transfers undertaken during the month must also be reported.

2. Reconfirmation of ODI positions: the issuers of ODI must carry out the reconfirmation process of the ODI positions on a semi-annual basis. Further, if there is any divergence from the reported monthly data, the same shall be informed to SEBI.

3. Periodic Operational Evaluation: The issuers of ODI are required to put in place such systems and carry out a periodical review and evaluate its controls, systems, and procedures in regard to ODIs. The certificate will be issued on an annual basis to SEBI by the Chief Executive Officer (CEO) or equivalent and shall be filed within one month from the end of every calendar year.   

4. Report Details: The following reports must be submitted for the previous month by the 10th of every month.

1. Monthly Summary Report-Statement of outstanding positions of Offshore Derivative Instruments
2. ODI Activity
3. Details of underlying trades in the Indian Market for debt instruments
4. Details of underlying trades in the Indian market for derivative instruments
5. Details of underlying trades in the Indian market for hybrid instruments
6. Details of assets under management in India Market for Equity
7. Details of assets under management in India Market for Debt
8. Details of assets under management in the India Market for Derivative
9. Details of assets under management in India Market for Hybrid
10. Statement on beneficial owners of ODI subscribers
11. Reconciliation or Reconfirmation Report

Conclusion

To regulate offshore derivative instruments, the SEBI has required foreign portfolio investors to comply with the conditions and conduct the KYC before transacting any instruments. Also, the foreign portfolio investor must adhere to the requirements to avoid any non-failure of compliance. Further, the FPI must be required to maintain the KYC document mentioned above from each category for due diligence. Moreover, the report for such transactions shall be made available to SEBI for their scrutiny.

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