Differentiate between Offshore Derivative Instruments (ODI) and Participatory Notes (PN). Why SEBI has a cautious approach towards these instruments? Discuss highlighting recent SEBI order towards these instruments.

Offshore Derivative Instruments ODIs are vehicles of investment used by overseas investors to get exposure to Indian equities and other equity derivatives. These investors do not get registered with SEBI mainly because of personal choice and also due to regulatory restrictions. These overseas investors usually purchase via FII who is already registered with SEBI. The affiliate of the FIIs issues the ODIs to these investors. ODIs usually have stocks or equity derivatives as underlying assets.
P-notes, on the other hand, is a type of ODI and are instruments issued by FIIs to the overseas investors who want to invest in Indian Stock market without formally registering with SEBI. They are also called Equity Linked Notes, Capped Return notes and Participating Return notes etc.

  • P-notes and ODIs are freely tradable and can thus be easily transferred. There is a risk of creating multiple layers thereby ignoring the real owner.
  • There are also concerns about the source of money coming in the country via P-notes i.e. the unaccounted wealth can find its way back under the aegis of foreign investment.
  • There is apparently less accountability and transparency in this route.

Steps taken by SEBI to ensure compliance and accountability:

  • Prohibition on FPIs to issue ODIs against derivatives except for hedging purposes.
  • All the existing ODIs against derivatives which are not for hedging purposes have to be dissolved by maturity date or December 31, 2020, whichever is earlier.
  • For all new ODIs to be issued against derivatives a certificate has to be issued by the compliance officer thereby confirming the position of the derivative.

A significant number of changes have been introduced over the ODI route in the last decade viz. reducing the number of eligible entities, increased compliance, know-your-customer (KYC) and many other duties of issuer FPI. The recent changes proposed by SEBI stand for ensuring better compliance and reporting alongwith reasonable restrictions to trim the P-note market. The obligation introduced on part of the compliance officer will go a long way to increase the personal liability of the important personnel of FPI. The tightening of the route will encourage direct registrations. Also, the fee of  $1000 per subscriber will knit the gap between direct and indirect access routes. The changes will also force subscribers with unhedged derivatives to unwind.
SEBI has to thus maintain a strong balance along with effective regulation and decisive enforcement for the welfare of securities market.


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