Sebi tightens ODI guidelines to curb speculation and improve market integrity

The market regulator has introduced new regulations that seek a clear separation between offshore derivatives (ODIs) and foreign portfolio investors (FPIs) and has mandated greater disclosure to reduce systemic risks in Indian capital markets.

ODIs are investment vehicles that allow foreign 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 an August 2024 proposal to harmonize disclosure requirements for FPIs and extend them to ODI subscribers.

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

To limit the concentration of foreign influence, Sebi has also imposed a limit on ODI positions associated with a single corporate group. ODI subscribers may not hold more than 50% of their equity positions in securities related to a single Indian corporate group. In addition, a 3% limit has been introduced on the cumulative holdings of FPIs and ODI subscribers in the top company of a group of companies without an identified promoter, with a requirement to reduce or disclose holdings above this threshold.

To give market participants time to adapt, Sebi set transition 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 time frame. FPIs with outstanding ODIs are also required to obtain separate registrations before this deadline. These measures are intended to increase transparency and reduce systemic risks in Indian financial markets.

The ban on derivatives-based ODIs and mandatory detailed disclosure of ownership rights would improve transparency and curb misuse of ODIs by opaque entities, said Ashish Padiyar, co-founder of asset management firm Bellwether Associates.

“The 3% limit on investments in top companies prevents excessive foreign control in critical business groups,” Padiyar said. “The requirement that ODIs be fully hedged with the same underlying securities will limit the risks of excessive leverage, but compliance costs for FPIs may increase, potentially deterring smaller investors.”

According to Narinder Wadhwa, Managing Director and CEO, SKI Capital, Sebi’s actions will reduce speculative activities in the derivatives market and increase market stability. “By banning 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 burden on FPIs, which may have to overhaul their operational structures to meet the new registration requirements. FPIs are likely to have to adjust their investment strategies, especially those that previously relied on derivatives ODIs.

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

Ownership Disclosure

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

These disclosures are required when ODI subscribers own more than 50% of their shares through the issuing FPI or when their share holdings 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 because they pose lower regulatory risks.

The new regulations will increase transparency in the activities of FPIs issuing ODIs, said Anita Gandhi, founder and head of institution at Arihant Capital Markets Ltd. “By separating 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 risk and bring more transparency to the market. “While higher 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 derivatives-based ODIs could reduce liquidity, the overall long-term impact would be positive as Sebi’s measures are expected to lead to a more resilient stock market, he said.