Participatory Notes Simplified

The Supreme Court recently appointed SIT (Special Investigation Team) on Participatory Notes. This team was mainly to check and measure the investment through Participatory notes. The market reacted negatively post this announcement on 27th July, 2015. However, market later stabilized once the Finance Minister Arun Jaitely said Investors need not fear any Knee-Jerk reaction from the government on the SIT report. ;;

How often we have seen the market become nervous on any announcement of ban or through regulations on Participatory Notes. We have seen market opened on lower circuit on 17th October, 2007, when SEBI announced a ban on P-notes a day earlier. This led to suspension of trade for the first hour. However, later it recovered all its losses on the same day after the Finance Minister at that time, P Chidambaram issued clarification that the government was not in favour of banning P-notes immediately. ;;

At the peak of the bull market of 2007, 50% of FII investment was through P-Notes which has currently come down to 20-25% of the total FII investment. However, the regulators are worried at the quantum of P-notes that is still over 2.5 lakh crore and any tough regulation on P-notes will induce nervousness in the market. With our market mainly dependent on FII&;rsquo;s, we expect government will not take any harsh step which could shake the dalal street. However, for investors who want to understand Participatory notes, we have simplified the same as given below. ;;

P-notes, an acronym for Participatory notes, also known as off-shore derivative instruments. These instruments are being issued by a registered FII with SEBI to the foreign investors who want to invest in India. ;;

A foreigner in order to invest in India, apart from passing through several regulations must compulsorily have a PAN card as well as a DEMAT account, in absence of which he/she is not eligible to invest. So, in order to avoid this hassles for off shore investors to enter through FII&;rsquo;s. There are some FII&;rsquo;s which are registered with the market regulator. In India, the FII&;rsquo;s would be registered with SEBI, who is the Ombudsman for the securities market. These registered FII&;rsquo;s have a Pan Card as well as a Demat Account for themselves. The foreign investor usually transfer their funds to these FII&;rsquo;s, who in turn buy shares on behalf of the investors which remain in the DEMAT account held by the respective FII. In return, these FII&;rsquo;s give a Participatory note which would state the holdings of the foreign investors. In return, the foreign investor gives certain basis points or bps of the values of PN&;rsquo;s traded, which will be the fee income for the FII&;rsquo;s who issues the p-notes. ;;

Prior to 2011, SEBI did not have sufficient resources to have a knowledge about whom the P-Notes were being issued and whose money is being invested in the stock markets. But after FPI (foreign portfolio investors) 2014 regulations was issued, the capital market watch dog has imposed restrictions upon the people who can issue as well as who can subscribe to the Participatory notes. The P-Notes cannot to be used by an Indian company or an Indian entity, but in some of the transactions which came under SEBI&;rsquo;s surveillance, the Ombudsman observed that the there are certain companies making investment in their own companies shares by opening investment account in some other countries. In 2011, SEBI has issued a rule specifically mentioning that no Indian person or person of Indian origin can invest in Indian securities through P-notes route. It has also given a mandate for FII&;rsquo;s that they should provide a certificate stating that there is no investment in the Indian Stock Exchanges by an Indian or Indian entity through the said route. The list is not being circulated in the general public.

In this regard, SEBI has taken one more step, if the capital market regulator has any suspicion in any of the holdings by a foreign investor, the FPI&;rsquo;s are obligated to provide information in this regard. SEBI has a track of each and every investor who has invested in India market through the route of FII&;rsquo;s issued Participatory note.

SEBI has also mandated that if an FII is from certain jurisdiction only then they can issue P-notes to the concerned investor. The jurisdiction which the SEBI is following is that being demarcated by FATF which is an acronym for Financial Action Task Force which is being established for curbing money laundering and terrorist financing. Currently, 34 countries and two regional jurisdictions are part of FATF. India has been the part of the FATF since 2010.