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HDFC Bank FPI trades: What exactly happened on Friday and who is to blame?

LiveMint logoLiveMint 22-02-2017 Jayshree P Upadhyay

Mumbai: The confusion around HDFC Bank Ltd breaching its foreign ownership limit may have been caused by a coordination issue between various parties involved, said three people in the know.

It led to some brokers having to take some trades made on Friday on their proprietary book—a situation that could have been avoided as it hits the very foundation of markets, experts said.

Here’s a quick recap of what happened: On Thursday, the Reserve Bank of India lifted a ban on foreign portfolio investors (FPIs) buying HDFC Bank shares after foreign ownership dropped below 74% of paid up capital. The next day, HDFC Bank shares climbed as much as 9.24% because of latent foreign investor demand. At 1.38pm on Friday, RBI put out another notification, banning further FPI buying because the foreign shareholding breached the 74% allowed by law.

However, it also asked that brokers, who punched in trades for foreign clients after its 1.38pm notification banning further buying, take these trades on their books. The value of trades that took place after the foreign ownership limit was breached is between Rs8,000 and Rs10,000 crore, Mint reported on Monday. Total HDFC Bank trades across BSE and NSE amounted to Rs22,000 crore on Friday.

Market experts are questioning the wisdom of RBI’s move as it amounted to interfering with trading during market hours. The Securities and Exchange Board of India (Sebi) does so only when the circuit limits are hit as an exigency measure. “The fundamental objective of financial markets is to uphold the sanctity of the trade. Once a trade takes place, nobody should ever think it can be unravelled,” said Ajay Shah, professor, National Institute of Public Finance and Policy.

“Reopening of trades is what happens in malfunctioning financial systems. It will be extremely unpleasant if the risk of trade cancellation by financial agencies is increased through RBI/Sebi actions.”

Typically, RBI is given a trigger warning as soon as the foreign shareholding hits 72% of paid up capital of a bank. The stock is then put under a watch list and any further trades by FPIs need to be pre-approved. 

This entire process did not work as envisaged, according to the three people cited earlier—a Sebi official, an executive with a stock exchange and a broker who has FPI clients. 

“Generally, the computation of FPI limit is done after end of the day’s trade, for which we rely on the settlement data from depositories,” said the exchange official. 

It is not clear how RBI reached the conclusion that foreign holding breached 74% in the middle of the day. An RBI spokesperson declined to comment.

"RBI should not interfere with settlement processes of exchanges,’ said Deena Mehta, managing director at Asit C. Mehta Investment Intermediaries Ltd and former president of BSE. “If there was a situation where the FPI limits were being breached, the central bank could have coordinated with exchanges and Sebi to handle the situation better. Such a panicked reaction was not warranted.”

Following the fiasco, the two regulators, Sebi and RBI, are looking for fixes and strengthening their monitoring mechanism.

“A quick-fix would be to avoid the RBI route and ask exchanges to stop accepting buy orders without awaiting a notification from RBI. However, the larger question is how do we design capital controls such that monitoring does not impose a cost on anybody,” said Shah of NIPFP.

“One example of this is to replace our existing system of capital controls by a Chilean-style system where there is a tax on inflows, but after that there are no restrictions upon non-resident participants in the local financial system of any kind,” said Shah.

Currently the regulatory systems don’t have a fair and legally tenable solution. 

“The policy framework needs to be strengthened by ensuring real time coordination between custodians, depositories, stock exchanges and RBI and automated blockage of trades in case limits are reached and immediate notification to that effect. With technological advancement, this should not be difficult to achieve,” said Tejesh Chitlangi, partner at law firm IC Legal.

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