The Adani-Hindenburg Fallout and Changing Dynamics of Foreign Portfolio Investments

The Hindenburg research report concerning the Adani Group has once again surfaced in recent news, as the regulatory body overseeing the stock market seeks an extension for presenting the status report to the Supreme Court. With the regulatory authority implying that its investigation is nearing conclusion, it points towards intriguing times ahead for foreign portfolio investors (FPIs) employing the Mauritius pathway for transferring funds to India. The report casts light on a widely acknowledged yet concealed practice – the infiltration of domestic capital into Indian stock markets camouflaged as FPI investments, facilitated through tax-favored jurisdictions like Mauritius, Luxembourg, and Singapore. The revelations made by the Hindenburg report have once again thrust these covert practices into public scrutiny.

Unveiling the Persistence of Disguised FPI Inflows

The Hindenburg report identifies 38 shell entities situated in Mauritius, controlled either by Vinod Adani or his associates. A significant number of these entities conspicuously lack operational substance, with no documented workforce, independent addresses, contact numbers, or substantial online presence. These shell companies, often structured in intricate multi-layered formations, are engineered to obscure true ownership. However, the ongoing scrutiny of the Adani case by the Securities and Exchange Board of India (SEBI), closely monitored by stakeholders, could act as a tipping point for these Mauritius-based shell entities. Already, FPI and foreign direct investment (FDI) inflows originating from this jurisdiction have seen significant declines. As regulatory scrutiny tightens further, the allure of Mauritius as a conduit for fund transfers could diminish further.

Evolving FPI Landscape: Shifting Fortunes of Mauritius

SEBI’s data over the past decade underscores substantial shifts in the origins of foreign portfolio funds, attributed primarily to heightened scrutiny and the retraction of tax advantages. In the past, by December 31, 2012, Mauritius accounted for 26% of the assets under the custody of foreign investors, ranking as the foremost source of FPI resources, followed by the US. Singapore and Luxembourg claimed portions of 13% and 8%, correspondingly.

However, the landscape underwent a transformation, with the US overtaking Mauritius as the primary source of FPI investments. By July 2023, FPIs from the US held a commanding 39.32% of FPI assets under custody, amounting to ₹22,62-lakh crore. Singapore and Luxembourg trailed at 9% and 7.3%, while Mauritius lagged at 6.5%. This transition resulted in a substantial influx of ₹19.19-lakh crore in FPI funds from the US, with Singapore and Luxembourg collectively contributing about ₹6.5-lakh crore. Meanwhile, the FPI assets emanating from Mauritius remained static between 2012 and 2023. If we exclude the impact of capital appreciation, these assets would even indicate a decline.

Tax Treaty Adjustments: Erosion of Mauritius’ Standing and Ascendance of the US

Mauritius was once an advantageous choice for foreign portfolio and direct investors due to the Double Tax Avoidance Agreement (DTAA)1, exempting them from capital gains tax. This exemption had strong appeal, allowing investors to entirely evade capital gains taxation. However, alterations to the DTAA framework have altered this landscape, leading to the taxation of capital gains within India for shares procured after April 1, 2017. Singapore, closely linked to Mauritius due to shared tax agreements, also witnessed its investments subject to Indian taxation.

As a result, the number of foreign investors and the funds funneled through Mauritius saw a steep decline, as other jurisdictions like the US appeared more enticing. This transformation could also be attributed to the Federal Reserve’s accommodative monetary policy during the pandemic, injecting more funds into the US market, some of which potentially flowed into high-growth emerging markets like India.

US Dominance and the Role of Luxembourg

The US maintains a commanding lead concerning FPIs registered with SEBI, boasting 3,464 registered FPIs. By contrast, Mauritius only accounts for 576 FPIs. Intriguingly, Luxembourg houses a substantial number of FPIs, totaling 1,275. This discrepancy could be attributed to heightened scrutiny on fund flows from Mauritius, potentially resulting in a diversion of dubious flows towards Luxembourg. This underscores the shifting dynamics of tax havens and their allure to foreign investors.

The Consequences of the Adani-Hindenburg Situation: Impact on FPI Flows and Money Laundering

The revelations from the Hindenburg report are poised to exacerbate the downward trend of FPI flows originating from Mauritius. With the loss of tax benefits, the Mauritius channel has primarily transformed into a conduit utilized for money laundering or manipulation of domestic share prices through overseas transactions. Although attempts by Indian tax authorities and market regulators to gain insights into these shell entities have been undertaken, success has been limited. The report underscores substantial gaps in the regulatory framework of the island nation, enabling the establishment of shell companies designed to facilitate the circumvention of funds back into India.

SEBI’s Reaction and Prospective Regulatory Modifications

Recent actions taken by SEBI, such as mandating FPIs to disclose ultimate beneficiaries and requiring those with significant stock concentration to divulge intricate shareholding details to custodians, underscore the intent to clamp down on illicit practices originating from tax havens. If SEBI’s inquiry into the Hindenburg report unveils the precise strategies employed by the Adani group to mask ultimate ownership, it is likely that a new set of regulations will be introduced to address existing loopholes. This could result in an increased migration of so-called FPIs away from Mauritius.

India’s Consistent Allure and Concluding Observations

Despite these shifts, the substantial inflow of foreign portfolio funds into India during the pandemic and subsequent periods underscores the nation’s enduring attraction as a favored destination for foreign investment. Consequently, although concerns regarding external accounts and the rupee endure, endeavors to curb money laundering and uphold transparency within foreign investments remain imperative for upholding India’s reputation as a trustworthy investment hub.

Envisioning an Alteration in Regulatory Approach: The Future of FPI Investments

As SEBI’s examination of the Hindenburg report progresses, the potential ramifications might extend well beyond the Adani case. The revealed gaps and behaviors are likely to galvanize policymakers and overseers into motion, prompting a comprehensive reconsideration of FPI regulations. These adjustments could encompass more stringent reporting prerequisites, heightened due diligence steps, and increased scrutiny of offshore entity ownership structures. The ultimate objective would be to establish a more lucid and responsible investment environment, nurturing equitable conditions for all participants.

Rethinking the Role of Tax Havens: Insights from the Mauritius Incident

The Mauritius incident stands as a cautionary anecdote concerning the role of tax havens in the worldwide financial panorama. Although these jurisdictions have traditionally enticed foreign investments due to advantageous tax benefits, evolving regulatory dynamics have exposed their susceptibilities. The ease with which shell entities can be established for dubious intentions underscores the necessity for international cooperation in countering money laundering and illicit fund streams. This occurrence presents a timely occasion for governments, financial institutions, and international entities to collaborate on formulating a more robust and accountable framework for transnational investments.

In Conclusion: Navigating a Revolutionary Phase in FPI Investments

The ongoing disclosures arising from the Adani-Hindenburg saga and the evolving dynamics of FPI investments denote a transformative juncture for India’s financial markets. The regulatory panorama is on the cusp of recalibration, signifying a departure from the era of obscurity and unregulated financial maneuvers. While investors, policymakers, and regulators partake in an intricate interplay to reinstate trust and clarity, one aspect remains evident: India’s allure as a sturdy investment hub will endure, propelled by its dynamic economy, burgeoning prospects, and unwavering dedication to sound governance. Amidst charting this novel trajectory, stakeholders shoulder the collective duty to construct a financial framework thriving on legitimacy, responsibility, and mutual reliance.

  1. Double Tax Avoidance Agreement (DTAA)
    It is a treaty signed between two countries to prevent the same income from being taxed twice in both countries. The purpose of a DTAA is to provide clarity on the tax liabilities of individuals and entities that have income in both countries, and to encourage cross-border trade, investment, and economic cooperation.
    The primary goal of DTAA is to eliminate or reduce instances of double taxation, which can discourage international trade and investment. ↩︎

2 thoughts on “The Adani-Hindenburg Fallout and Changing Dynamics of Foreign Portfolio Investments”

    • sure Richa,
      but to do so, We’ll need a bit more time to gather relevant information, studies, and examples that can enrich the content.
      Thanks for your patience.
      PS:- Thankyou for reaching out and suggesting the topic


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