Participatory Notes (P Notes)
P Notes
Financial instruments used by investors or hedge funds that are not registered with the
Securities and Exchange Board of India to
invest in Indian securities. Indian-based brokerages buy India-based
securities and then issue participatory notes to foreign investors. Any
dividends or capital gains collected from the underlying securities go
back to the investors.
* Note –> P-notes are no need to register with SEBI , they are derivates of FIIs
P-NOTES working
Participatory notes are instruments used for making investments in
the stock markets. However, they are not used within the country. They
are used outside India for making investments in shares listed in the
Indian stock market. That is why they are also called offshore
derivative instruments.
In the Indian context
, foreign institutional investors (FIIs) and
their sub-accounts mostly use these instruments for facilitating the
participation of their overseas clients, who are not interested in
participating directly in the Indian stock market.
For example, Indian-based brokerages buy India-based securities and
then issue participatory notes to foreign investors. Any dividends or
capital gains collected from the underlying securities go back to the
investors.
* p-notes pool the individuals into derivate of FIIs
Example — P-NOTES — applicants are 100 people with short investments
Example of each 10 lakh can make into pool and investment in stock market as combined form
* overseas clients showing interest on buying shares like blue chip companies
INFOSYS, WIPRO, HCL, TCS etc….
they will invest in the p-notes –> It leads to money laundering
& black money curbs into the stock market ( As it having no
registration to sebi and participants details )
RECENT P-NOTES in news & SIT clarification
- P-notes are popular as it allows the idenity of the investor to be
kept anonymous. FIIs are required to register with SEBI, but P-notes who
trade through them are not.
- No wonder P-notes have been controversial instruments from the start
and every time the government wants to regulate them, market start
falling preventing the government to take the harsh step. The government
fears that P-notes are being used as instruments for money laundering.
- Even listed company promoters are believed to re-route their
investments in their own companies through the P-note route. This allows
them to flout the stringent insider trading norms that regulate such
proprietary investments.
- P-notes however, have other inherent advantages. They are easy to
operate rather than the cumbersome rules that India has for its foreign
investors. P-notes are like contract notes transferrable by endorsement
and delivery. This nature of P-notes has attracted the SIT’s attention
and rightly so.
- P-notes are freely traded overseas, and is done without any
jurisdiction or control of SEBI over it. This nature of P-note is like
that of an informal ADR (American Depository Receipt) where the stocks
are held by brokerages for their foreign investors.
- Since P-notes are opaque and the identity of the owner is known only
to the FII, trading them freely makes it very difficult to find the
original owner of these P-notes.
- However, SIT’s decision to seek a clarification is a welcome move.
For the markets, knowing the identity of the participant is healthy, but
the initial reaction to the news seems to be a knee-jerk reaction.
Further, SIT has asked for stricter compliance norms of P-notes and has
said nothing on banning them.
- Share of P-notes has already come down from 50 per cent in 2007 to
around 11.5 per cent presently. However, memories of the sharp 1744
point fall on October 17, 2007 and subsequent volatilities on following
days when SEBI first proposed curbs on P-notes is enough to spread fear
in the mind of investors and government alike.
What are Participatory Notes (or P-Notes, as they are commonly referred to)
In 1992, India allowed Foreign Institutional Investors (FIIs) to buy
stocks listed on Indian exchanges. However, all investors, whether
institutions or individuals, were required to register themselves with
the capital markets regulator, Sebi. To get around these restrictions,
FIIs started to issue so-called participatory notes (or PNs) to
investors who, for various reasons, wanted to remain anonymous
Since PNs tracked the value of Indian stocks, their values rose or fell according to the movement of the markets.
Initially, nobody complained, as FIIs generated a lot of business
from monies routed through them and their accounts. These monies fuelled
the market boom from the early period of liberalisation. At their peak
during 2007, the value of PNs constituted well over 50 per cent of the
outstanding assets in the custody of FIIs
Participatory Notes Crisis of 2007
On the 16th of October, 2007, SEBI (Securities & Exchange Board
of India) proposed curbs on participatory notes which accounted for
roughly 50% of FII investment in 2007. SEBI was not happy with P-Notes
because it is not possible to know who owns the underlying securities
and hedge funds acting through PNs might therefore cause volatility in
the Indian markets.
However the proposals of SEBI were not clear and this led to a
knee-jerk crash when the markets opened on the following day (October
17, 2007). Within a minute of opening trade, the Sensex crashed by 1744
points or about 9% of its value – the biggest intra-day fall in Indian
stock-markets in absolute terms. This led to automatic suspension of
trade for 1 hour. at that time –>
Finance Minister P.Chidambaram
What has the SIT on black money said?
Why is the stock market worried?
In its third report, contents of which were released on Friday, the
SIT recommended that the government should obtain details of beneficial
ownership — or identity of the final holder or investor — of P-Notes,
and make it non-transferable. The SIT wants investors due diligence — or
KYC — details to be known to the regulator. It has also made the point
that a bulk of P-Notes investments were from overseas jurisdictions such
as the Cayman Islands, a tax haven that accounted for 31 per cent of
all foreign inflows from offshore derivative instruments. The worry is
on account of the fact that the outstanding value of PNs at the end of
February 2015 was 2.85 lakh crore —
which, if unwound, can lead to carnage in a market where local
institutional investors are not as influential. Finance Minister Arun
Jaitley has, however, assured that there would be no kneejerk reaction.
“kneejerk reaction” –> By finance minister —Arun Jaitley
To soothe nerves of foreign investors after an SIT on black money
suggested stricter norms for P-Notes, the government today said it will
not take any “knee-jerk” reaction that will will adversely impact
country’s investment climate.
With markets tanking on the recommendations of the Supreme
Court-appointed SIT on black money last week that Sebi should tighten
norms related to Participatory Notes (P-Notes) investments into India,
Finance Minister Arun Jaitley said the government will study the
suggestions before taking a stand.
Finance minister, Arun Jaitley, who was heavily criticised on the
issue of application of MAT on FIIs, seems to be a quick learner. His
ministry has issued statements assuring investors that the government
will not take steps that will affect investments, following the SIT
report.
U.K.SINHA –> on P-notes
- Sebi has progressively tightened rules governing participatory notes
(PN) and is aware of the identity of their owners, the market
regulator’s chairman UK Sinha has said.
- Sinha pointed out that both issuers and buyers of PNs have to be
from countries compliant with regulations of the financial action task
force (FATF). FATF is an inter-governmental body tasked with curbing
illicit finance at a global level.
What are the broad concerns about P-Notes?
Concerns have been expressed over anonymous investors who are beyond
the reach of Indian regulators or taxmen, and over indications that
wealthy Indians, including promoters of Indian companies, have been
using this route to bring back unaccounted funds and to rig their
stocks. The concerns were first flagged by the Joint Parliamentary
Committee on the 2001 securities market scam, which said that P-Notes
enabled their holders to conceal their identities. The committee also
pointed to the links that stock market player Ketan Parekh had with
foreign entities, which allowed him to allegedly rig stocks, and to the
role of Overseas Corporate Bodies or OCBs owned predominantly by Indians
in the stock market crash. The JPC wanted action on these issues.
What has Sebi done so far to regulate P-Notes?
In 2004, Sebi tightened rules to ensure PNs were issued — and
transferred — only to regulated entities. On October 16, 2007, against
the backdrop of a surge in capital flows and excess liquidity, the
regulator banned P-Notes. M Damodaran was Sebi chief then, and
P.Chidambaram was Finance Minister. The markets crashed immediately,
but recovered after the regulator unveiled rules a week later, saying
FIIs could not take any fresh exposure, and their existing investments
would have to be wound up in 18 months. But exactly a year later, during
the tenure of Damodaran’s successor, C B Bhave, all restrictions on PNs
were removed in the wake of the global financial crisis, amid fears of
capital outflows. But rules were tightened again subsequently.
Why is it difficult to ban P-Notes?
The RBI may be pushing hard, but the government, which has the final
say in foreign investment rules, appears to be reluctant to impose a
full ban, presumably because of a fear that the stock markets would
tank, and there would be a flight of capital.
With FIIs now controlling 20 per cent of the free float in listed
Indian companies, policymakers would want to think several times,
especially in a country which runs a current account deficit and needs
foreign investment to bridge the gap in savings.
During the UPA government’s tenure, a committee headed by the then
Chief Economic Advisor, Ashok Lahiri, released a report in November
2005 on encouraging FII flows and checking the vulnerability of capital
markets to speculative flows.
The committee suggested measures such as greater broadbasing of
foreign entities investing in the Indian market, and a ceiling on FIIs
and their sub-accounts. The majority view, however, was that the
existing dispensation for PNs ought to continue. In a move that was rare
for a situation in which a government-led panel was involved, the RBI
dissented, arguing that PNs should not be permitted because it remained
difficult to identify their final holders.
So, what policy options are available on PNs?
With more broadbased flows and greater global pressure now on
checking illicit fund flows, it should be possible to phase out PNs over
the medium term. That is, if it is grandfathered — or, in other words,
spread out over a specified period with a sunset clause. That should go
hand in hand with reforms in taxation, including greater clarity, easier
norms, lowering of transaction costs, and encouraging more local
institutional investors — especially pension funds and FDI — to reduce
reliance on volatile flows.
