A Substance Over Form Imperative for SEBI – IndiaCorpLaw
[Mustafa Rajkotwala and Shamik Datta are lawyers based in Mumbai]
Tracker shares and total return swaps (“Three”) are sophisticated financial instruments that allow foreign investors to synthetically replicate exposure to Indian equity markets. These instruments have gained prominence as alternatives to traditional participatory notes (“P-notes”), offering similar economic outcomes while circumventing scrutiny under SEBI’s offshore derivative instruments (“ODI”) regime governed by the Foreign Portfolio Investors Regulations, 2019(“FPI Regulations”). Unlike P-notes, which are directly regulated, tracker shares and TRSs exploit structural arbitrage to achieve synthetic exposure without triggering equivalent compliance obligations, thereby raising critical questions about the efficacy and scope of India’s current regulatory framework.
Both TRSs and tracker shares use offshore structuring to synthetically replicate Indian equity exposure while avoiding SEBI’s ODI classification. By tracking baskets of Indian equities and settling entirely offshore, they bypass the “securities held by it in India” requirement (regulation 2(1)(o), FPI Regulations) and elude custodial safeguards, disclosure obligations, and beneficial ownership visibility. Through this, such transactions expose significant regulatory blind spots in both SEBI and RBI oversight.
Recently, SEBI has barred FPIs from issuing P-notes with derivatives as the underlying as part of its December 2024circular tightening ODI compliance, aiming to curb speculative trading and enhance market transparency. However, both tracker shares and TRS continue to exploit similar regulatory gaps by offering synthetic exposure to Indian equities without falling within SEBI’s definitional framework, thereby enabling opacity and compliance arbitrage that undermines market transparency.
This post argues that SEBI’s existing ODI framework, which remains tied to the legal form of the instrument, is no longer equipped to address the realities of modern cross-border investment structures. It is proposed that a new category of “synthetic ODIs” be introduced, based on the principle of economic exposure. This would bring any arrangement that replicates the risks and returns of direct investment in Indian securities, regardless of its legal form, within SEBI’s regulatory ambit.
Understanding the Regulatory Gap
Under the FPI Regulations, ODIs are defined as instruments “issued overseas by an FPI against securities held by it in India.” Tracker shares and TRSs are structured precisely to avoid falling within this definition. In a TRS, for example, a foreign dealer agrees to pass on the returns of an Indian stock or index to an investor, without transferring any actual ownership. The dealer may hedge its exposure by holding Indian shares on its books, but this does not legally bind the economic interest to the investor. Similarly, tracker shares are issued by offshore vehicles whose value is linked to the performance of Indian equities, but which are not themselves classified as ODIs.
These instruments deliver the same economic effect as P-notes but are not subject to any of the accompanying disclosure, custodial, or eligibility requirements. This creates an uneven playing field and opens the door to regulatory arbitrage. The broader concern is not only about formal non-compliance, but about the lack of transparency these instruments create in the Indian market.
Global Regulatory Frameworks: Looking Beyond Form
Several major jurisdictions have already responded to similar challenges by extending regulatory oversight to synthetic equity exposures. In the United States, the landmark decision in CSX Corp v The Children’s Investment Fund held that a hedge fund that had entered into TRSs referencing CSX stock had effectively acquired beneficial ownership for the purposes of disclosure under section 13(d) of the Securities Exchange Act. The Court relied on the anti-evasion provision in rule 13d-3(b), which focuses on arrangements structured to avoid disclosure.
The European Union has adopted a layered approach. Under the Short Selling Regulationany short position, whether direct or synthetic, must be reported once it crosses 0.1 percent of a company’s share capital. Similarly, the European Market Infrastructure Regulation (“EMIR”) mandates reporting of all derivative contracts, including TRSs, to trade repositories.
In the United Kingdom, the Disclosure and Transparency Rules require disclosure once a person accumulates a 3 percent stake through any combination of direct holdings and financial instruments having a similar economic effect, including cash-settled derivatives. In all three jurisdictions, the trend is clear. Disclosure is triggered not by legal title alone, but by economic substance.
India’s Inconsistent Approach
In recent months, SEBI has taken significant steps to tighten the ODI regime. Following concerns around concentrated exposure and beneficial ownership, new thresholds have been introduced for granular disclosures. Effective from November 17, 2025, pursuant to a SEBI circular dated May 16, 2025, the rules now mandate full transfer tracking, sub-account look-through, and end-investor identification for P-notes. This extension from the earlier deadline of May 17, 2025, was granted based on representations received from market participants and to ensure smooth implementation of the revised compliance framework. But despite these efforts, the regulatory perimeter remains defined by form. As a result, instruments that replicate the function of ODIs remain entirely outside SEBI’s scrutiny.
This creates three key problems. First, investors using P-notes face regulatory obligations that others using TRSs or tracker shares can avoid. Second, market transparency suffers because large positions may be built up offshore without disclosure. And third, there is a doctrinal inconsistency between securities regulation and other areas of Indian law, such as tax and insolvency, which have embraced substance over form.
SEBI itself has acknowledged this approach in other contexts. In the Deccan Gold Mines informal guidance issued in 2023, SEBI held that contra trading restrictions under the insider trading regulations would apply across promoter entities with common shareholding. Even though the trades were carried out by legally distinct entities, SEBI looked at the underlying control and treated them as one for the purposes of the regulation. The reasoning focused on “ultimate beneficiaries” and “underlying objectives.”
Proposing a New Framework: Synthetic ODIs
SEBI should consider introducing a new classification of synthetic ODIs, defined to include any offshore instrument that provides economic rights substantially similar to ownership of Indian securities. This would cover tracker shares, TRSs, and other derivatives that track Indian market performance without triggering formal ODI issuance. A framework for regulating such instruments could potentially include the following components:
Disclosure Thresholds: Like the EU and the UK, SEBI could introduce tiered disclosure requirements. Private reporting to SEBI may be required at 0.1 percent or 0.5 percent exposure, with public disclosure triggered once exposure exceeds 5 percent. This should apply to aggregate holdings, including both direct and synthetic positions.
Beneficial Ownership Verification: Issuers of synthetic ODIs should be subject to the same eligibility and KYC norms as P-note issuers. End-investors must be from FATF-compliant jurisdictions and must satisfy the due diligence criteria that currently apply to FPI and ODI subscribers.
Tagging of Hedge Positions: Where a TRS dealer hedges its exposure by purchasing Indian equities, those trades should be tagged in custodial systems as hedges for offshore synthetic instruments. This would provide SEBI with visibility into the underlying exposure, even if the offshore contract is itself beyond direct jurisdiction.
Anti-Evasion Clause: SEBI should incorporate a general anti-avoidance provision in its ODI framework. Any arrangement that is designed to evade disclosure or position limits should be deemed an ODI and treated accordingly. The US approach under rule 13d-3(b) provides a useful precedent.
This framework would ensure that SEBI is not blindsided by large exposures built through synthetic routes. It would also close the compliance gap between different types of foreign investors.
The Broader Rationale
There is a growing consensus across Indian commercial jurisprudence that regulation must reflect economic reality. The Vodafone tax casethe introduction of GAAR, and the AAR’s ruling in ETrade Mauritius all reflect the principle that form should not defeat substance. In the context of foreign investment in Indian capital markets, the same logic must now apply.
The goal is not to prohibit innovation, but to ensure transparency. Synthetic structures, if left unregulated, risk enabling circumvention of position limits, insider trading norms, and beneficial ownership disclosures. By expanding the ODI regime to cover synthetic ODIs, SEBI can restore regulatory parity and enhance investor confidence.
SEBI’s August 2023 circular introducing a full look-through ultimate beneficial owner (“Cough”) disclosure framework for FPIs that meet specific equity concentration thresholds also reflects this shift towards economic substance. This framework, which focuses on the quantum and nature of exposure rather than legal form, should serve as a model for extending similar substance-based principles to synthetic instruments. As SEBI considers opening further access to NRIs and OCIs through IFSC-based FPIs, closing this synthetic exposure loophole becomes even more critical to maintaining regulatory credibility.
Conclusion
Tracker shares and TRSs are not new. But their growing use as ODI substitutes makes it necessary for SEBI to revisit its regulatory framework. International practice already supports a shift away from formal definitions. As offshore capital structures become increasingly sophisticated, SEBI must adopt a unified regulatory framework that looks beyond formal labels and targets the economic substance of exposure. Such a framework should apply jurisdiction neutral rules, mandate coordinated supervision between SEBI and RBI, and impose equivalent regulatory scrutiny on all instruments that replicate ODI economics, irrespective of their legal form, issuer, or structuring route.
A substance over form approach grounded in economic exposure and aligned with global norms would enable SEBI to capture the full spectrum of synthetic positions. If an instrument gives an investor the same exposure and influence as an ODI, then it must be brought within the same regulatory architecture.
– Mustafa Rajkotwala & Shamik Datta