The participatory notes short form or we may call it p-note are instruments used by investors and foreign funds who are not listed with the SEBI (Securities and Exchange Board of India) but they all are interested in taking investment in Indian securities. P-notes are commonly issued overseas by the associates of India based domestic institutional brokerages and foreign brokerages. They are, in fact, offshore derivative instruments issued by foreign institutional investors and their sub-accounts against underlying Indian securities. p-notes are issued where the underlying assets are securities listed on the Indian bourses.
Foreign institutional investors also use participatory notes because they do not wish to register with the Sebi but would like to take appearance/exposure in Indian securities. Brokers buy or sell securities on behalf of their clients on their proprietary account and issue such notes in favor of such foreign investors.
Why is P-notes so much in the news these days?
Participatory notes have attracted significant market attention recently because of the huge inflow of foreign funds into Indian stock markets through this route. Since the ultimate beneficiary of transactions carried out using participatory notes is not known to the market regulator and the tax authorities. there is a scope for misuse and tax avoidance. Also, since participatory notes dc not attract the attention of the market regulators of the countries in which the\ are issued, the entities holding p-notes virtually go unregulated.
A recent survey by the market regulator estimates that of the total Full investment of Rs. 90,000 crores in the country, nearly 25% (Rs. 24,000 crores) is accounted for by the issuance of participatory notes. A significant portion of the investment through participatory notes is also managed by just 14 entities. To put the matter in context, we could recall that the investigation of the ’01 securities scam revealed that nearly $2 bn was brought in or taken out of the country through overseas corporate bodies (OCBs) registered in Mauritius, whose beneficiaries were resident Indians.
The overseas corporate bodies funds were largely unregulated and caused a lot of volatility and a subsequent crash in the markets. There have been reports of late that market regulator – SEBI – had given the finance ministry a list of 30 overseas corporate bodies, which were banned from investing in the domestic stock markets after the ’01 stock market scam, to whom six foreign institutional investors have issued participatory notes. This included most reputed names in the industry. This has to be coupled with the fact that of the total foreign institutional investors inflow of Rs. 10,097 crore in October and November ’03, Rs. 5,756 crore came through p-notes. Also, what has stocked concerns is that most of the investment in ’03 through participatory notes started from May. Before April, such funds were to the tune of Rs. 2,000 crore. Fortunately, this investment is spread over ’00 scrips.
How has the SEBI reacted to all this?
The SEBI is set to further tighten its foreign institutional investor’s regulations to ensure that p-notes are not misused by non-resident Indians, overseas corporate bodies controlled by Indians or by Indian promoters, The SEBI board has taken an in-principle decision to restrict the issue of p-notes by foreign institutional investors to only regulated entities. This would mean closing the door on the issuance of participatory notes to entities like overseas corporate bodies, NRIs and Indian promoters, who the market regulator suspects of having misused the instrument to manipulate the market. Once these norms are notified, foreign institutional investors could be asked to wind up the accounts relating to p-notes issued to ineligible entities over a prescribed time-frame. An analysis by SEBI in ’03 had revealed that about 31 entities that had subscribed to participatory notes appeared to he overseas corporate bodies.