Participatory Notes

Stock markets in India are regulated by SEBI and all Foreign Institutional Investors, who invest in Indian stocks have to get registered with SEBI.  The two broad categories of foreign Investments viz. FDI and FII are highly regulated and need several approvals from SEBI. On the other hand, Participatory Notes is the alternative by which any Foreign Institutional Investor can enter Indian Capital Markets without getting registered with SEBI and going through the prescribed approval process.

Definition of P-Notes

Participatory Notes or P-notes are offshore derivative instruments, used by Foreign Institutional Investors (FIIs) who are NOT registered with SEBI. The major characteristics of P-notes are:

  • They are offshore derivative instruments
  • They are used by Foreign Institutional Investors (FIIs) who are NOT registered with SEBI.
  • They are used on Indian shares, but at a location outside of India.

The above implies that FIIs who are not registered with SEBI but wish to take exposure in the Indian securities markets can use P-notes. Brokers buy or sell securities on behalf of their clients on their proprietary account and issue such notes in favour of such foreign investors. The P-note holder is entitled to all the dividends, capital gains and other payouts on the underlying securities. The brokerages or FIIs have to compulsorily report the P-note issuance status every quarter to SEBI. In doing so, the identity of the client or the final investor can be hidden.

How the money flows in P-Notes?

The investors, who buy P-Notes, deposit their funds in the US or European operations of the FII, which also operates in India. The FII then uses its proprietary account to buy stocks in India. For example, a P-Note on Infosys or RIL can be issued by an FII or a foreign brokerage in say Mauritius to one of its clients there or from some other country. Equity-linked notes, capped return note, participatory return notes and investment notes are examples of some kinds of P-notes.

What is the major feature, which makes P-notes useful for investors?

One of the main features of the P-notes is that they conceal the investor’s identity. While one reason for using P-Notes is to keep the investor’s name anonymous, some investors have used the instrument to save on transaction costs also. Such investors look for derivative solution to gain exposure in individual, or a basket of, stocks in the relevant market. Sometimes, investors enter the Indian markets in a small way using P-Notes, and when their positions become larger, they find it advantageous to shift over to a full-fledged FII structure.

What is role of P-notes in Indian Economy?

Participatory notes (PNs) are instruments issued by SEBI- registered foreign institutions to entities that want to invest in Indian markets but do not want to directly register with the market, resulting in concealment of the investor’s identity. About 45 percent of total investments made by foreign instructional investors (FIIs) are through the P-notes. In the past, whenever the government has tried to control inflows through P-notes, it has faced strong opposition from FIIs. The ban of PNs has the capacity to erode the grains in shares of the past three years.

What are Advantages of P-notes?

P-notes are a convenient channel for high net worth individuals, large hedge funds etc. to enter Indian capital markets without going through the usual scrutiny like Know Your Customer (KYC) norms and other documentation with SEBI. This saves time and also helps maintain anonymity throughout. In addition to the anonymity clause, the P-notes are easily tradable as they are like contract notes which can be easily transferred by endorsement and delivery. Investors also prefer this vehicle to take advantage of the tax laws in some countries. The foremost advantage to invest via participatory notes is that they are completely outside Indian regulatory framework.

What are Disadvantages of P-notes?

P-notes where they provide a big kitty of advantages for anonymous overseas investors are a source of worry to SEBI as they have become an easy route for money laundering i.e. aid in movement of black money or unaccounted transactions. This is because, it is difficult to establish the beneficial ownership or the identity of the ultimate investor, and hence cannot be taxed. It is feared that FIIs, which have to comply with the know your customer norms, know the identity of the investor to whom P-Notes are issued. But it is possible for the investor to sell the P-note to another player resulting in multi-layering. Tax officials also fear that P-Notes are increasingly becoming a favourite among a host of Indian money launderers, who use the instrument to first take funds out of the country through the hawala route, and then get it back using P-Notes.

SEBI Norms on P-Notes

As they are issued outside India, so cannot be regulated. The anonymity clause further paralyses the market regulator to get to the real investor in case of any illegal transaction. SEBI has thus introduced new norms under which all P-notes will have to abide by Foreign Portfolio Investors Regulations. Further on, these won’t be allowed to be issued by a resident of a country identified by Financial Action Task Force as a “jurisdiction having a strategic Anti Money Laundering or Combating the Financing of Terrorism deficiencies to which counter measures apply. Likewise many more checkpoints have been laid down to effective control over the investment. Total investments via P-notes stood at $43 billion in October 2014.

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  • Dipak

    FII are registered with SEBI. please rectify it.