Sebi tightens ODI guidelines to curb speculation and improve market integrity

The market regulator has introduced new regulations seeking a clear segregation of offshore derivative instruments (ODIs) and foreign portfolio investors (FPIs) and mandated more disclosures to reduce systemic risks in India’s capital markets.

ODIs are investment vehicles that allow overseas investors to gain exposure to Indian equities or equity derivatives. While the ODI issuer owns the underlying securities, the economic benefits are transferred to the subscriber of these instruments.

The new regulations follow a proposal made in August 2024 to harmonize the disclosure requirements for FPIs and extend them to ODI subscribers.

A key change introduced by Securities and Exchange Board of India (Sebi) is measures to curb over-leveraging and speculative practices by prohibiting the hedging of ODIs with derivatives traded on Indian stock exchanges. Instead, ODIs must be fully hedged with the underlying securities on a one-to-one basis, reducing the systemic risks posed by derivative-based products.

To limit the concentration of foreign influence, Sebi has also imposed a cap on ODI positions linked to a single corporate group. ODI subscribers cannot hold more than 50% of their equity positions in securities related to one Indian corporate group. Moreover, a 3% cap has been introduced on the cumulative holdings of FPIs and ODI subscribers in the apex company of a corporate group with no identified promoter, with a requirement to reduce or disclose holdings exceeding this threshold.

To allow market participants time to adjust, Sebi set transitional deadlines. ODIs issued with derivatives as underlying assets must be redeemed within one year, and existing ODIs hedged with derivatives must be fully hedged with the underlying securities within this timeframe. FPIs with outstanding ODIs are also required to obtain separate registrations by this deadline. These measures aim to enhance transparency and reduce systemic risks in India’s financial markets.

The ban on derivative-based ODIs and the mandatory granular ownership disclosures would improve transparency and curb the misuse of ODIs by opaque entities, said Ashish Padiyar, co-founder of wealth management company Bellwether Associates .

“The 3% cap on holdings in apex companies prevents excessive foreign control in critical corporate groups,” said Padiyar. “The requirement for ODIs to be fully hedged with the same underlying securities will mitigate over-leveraging risks, but compliance costs could rise for FPIs, potentially deterring smaller investors.”

According to Narinder Wadhwa, managing Director & CEO of SKI Capital, Sebi’s actions will reduce speculative activities in the derivative market and increase market stability. “By prohibiting ODIs with derivatives as underlying assets, Sebi aims to limit excessive volatility, which will enhance the integrity of the market.”

However, he also pointed out the additional compliance burdens on FPIs, which may need to revise their operational structures to meet the new registration requirements. FPIs will likely have to adjust their investment strategies, particularly those who previously relied on ODIs with derivatives.

The circular also requires FPIs to issue ODIs only through a separate, dedicated FPI registration, which must have the suffix “ODI” to distinguish it from other FPIs.

Ownership disclosures

Sebi also mandated more detailed disclosure by FPI issuers of ODIs. They must collect and disclose comprehensive information about all entities with ownership stakes or control over the ODI subscriber on a “look-through” basis, down to individual natural persons.

These disclosures are required when ODI subscribers hold more than 50% of their equity through the issuing FPI or when their equity positions in India exceed ₹25,000 crore. Certain investors, such as government-related entities, public retail funds, and university endowments, are exempt from these disclosure requirements, as they pose lower regulatory risks.

The new regulations will enhance transparency in the operations of FPIs issuing ODIs, according to Anita Gandhi, founder & head of Institution at Arihant Capital Markets Ltd. “By segregating proprietary investments from client positions, these measures will reduce the potential for abuse.”

Nikunj Saraf, vice president at Choice Wealth, called it a “bold circular” that aims to reduce systemic risks and bring more transparency to the market. “While the increased compliance costs may discourage short-term players, these reforms are likely to attract long-term institutional investors who value stability and transparency,” Saraf said.

While the restrictions on derivative-based ODIs might reduce liquidity, the overall impact would be positive in the long term as Sebi’s measures are expected to lead to a more resilient equity market, he said.