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Indian Law Updates January 2019 Regulatory Practice

SEBI Circular on Artificial Intelligence (AI) and Machine Learning (ML) applications and systems offered and used by market intermediaries:

SEBI, through its circular released on 4 January 2019 has asked all registered stock brokers and depository participants using AI / ML based systems to submit the details of such systems in a prescribed form on a quarterly basis to the stock exchanges and the depositories. The stock exchanges and depositories shall further submit a consolidated quarterly report of all registered intermediaries using AI / ML applications and systems in a soft copy at prescribed email addresses to SEBI. The stock exchanges and depositories are also required to make necessary amendments to their bye laws, rules and regulations, make the provisions of the circular known to members and participants and communicate the status of implementation in their Monthly Development Report to SEBI.

The reporting is required if such systems are used by intermediaries to facilitate investing and trading or to disseminate investment strategies and advice or to carry out compliance operations / activities and where AI / ML is portrayed as a part of the product offering or for compliance or management purposes.

The circular also contains a list of systems which are deemed to be based on AI / ML systems. These include natural language processing systems such as robo chat bots, neural networks – systems modeling the brain such as some systems used for anomaly detection, machine learning such as those based on decision tree, systems using statistical heuristics, feedback mechanism or knowledge representation.

SEBI (Foreign Portfolio Investors) (Third Amendment) Regulations 2018:

These regulations, notified on 31 December 2018 seek to prohibit registration of foreign portfolio investors (FPIs) who are predominantly owned or controlled by non resident Indians (NRIs) or overseas citizens of India (OCIs) or resident Indians. For being eligible to register as FPI, the contribution to the corpus of the FPI from a single NRI/OCI/resident Indian is required to be less than 5% and the aggregate from all NRIs/OCIs/resident Indians is required to be less than 50% of the total contribution and the NRIs/OCIs/resident Indians should not be in control of the FPI. The definition of control has been brought in the regulations and includes the right to appoint majority directors or to control management or policy decisions. However, the disqualification does not apply to offshore funds in certain cases or non investing FPIs or FPIs investing only in units of schemes floated by mutual funds in India.

The regulations also prohibit registration of, and therefore investment from FPIs which are mentioned in the United Nations Security Council Sanctions List or FPIs which are from a high risk jurisdiction in terms of Anti-money laundering (AML) or combating the financing of terrorism (CFT) measures as identified by the Financial Action Task Force. FPIs with underlying investors of more than 25% corpus falling in the above criteria will also be barred from registering.

An applicant or an existing FPI which is predominantly controlled by NRIs / OCIs / resident Indians is mandated to comply with the above criteria within a period of two years from the effective date of the regulation or date of registration whichever is earlier. Existing FPIs which do not satisfy the sanctions / AML / CTF requirements are required to comply within a period of three months of the effective date of the regulation.

In order to be categorised as Category I FPI, government agencies will mean entities in which more than 75% ownership or control is held by Government of a foreign company.The transfer of offshore derivative instruments to entities disqualified from being registered as FPIs is also prohibited.

The investment limits of multiple FPIs having common ownership of more than 50% or common control will be clubbed, with the exception of FPIs which are public retail funds themselves or are regulated by public retail funds in certain cases.

SEBI (Substantial Acquisition of Shares and Takeovers) (Third Amendment) Regulations, 2018:

By virtue of these regulations dated 31 December 2018, SEBI has exempted housing finance companies (HFCs) registered with the National Housing Bank and systemically important non banking financial companies (NBFCs) recognised as such by the Reserve Bank of India from the requirement to make disclosures in relation to the shares aggregating to five percent or more of the shares of the target company taken as pledgee, where the shares have been pledged for securing indebtedness in the ordinary course of business. Such disclosures were earlier required to be made by the HFCs or NBFCs within two days of taking the shares as an encumbrance to the target company itself and the stock exchanges where the target company is listed.