Participatory Notes:
Foreign
investments are needed for the country to achieve a sustainable high trajectory
of economic growth. Foreign investment in India can broadly be classified
into two categories - Foreign direct investment (FDI) and investment made by
foreign institutional investors (FIIs). In both of these cases, foreign money
enters the Indian markets and fuels growth of economy, industries and capital
market.
However, with the number of increasing regulations in India, it is
not easy for foreign money to enter and exit the markets. There are strict
guidelines laid down by market regulator SEBI (Securities and Exchange Board of
India) for seeking approvals and documentation for FDI. The easy way for
overseas investors, who want to invest in the Indian stock markets without
getting into the regulatory approval process and other hassles is participatory
notes.
What is Participatory Notes ?
Participatory notes also called P-notes are
offshore derivative instruments with Indian shares as underlying assets. These
instruments are used by foreign investors who are interested in betting on
Indian securities but not interested in registering with the capital market
regulator SEBI. Participatory notes are not used within
the country. They are used outside India for making investment in shares listed
in the Indian Stock Market. That is why they are also called offshore
derivative instruments.Participatory notes are issued by
brokers and FIIs registered with SEBI. The investment is made on behalf of
these foreign investors by the already registered brokers in India. For
example, A registered FII buys Infosys shares from the Indian stock market. It
keeps the shares with itself and issues participatory notes based on these
shares to interested overseas investors.
Offshore Derivative Instruments/ Participatory notes holder doesn’t own the
Infosys shares. The p-note is just a kind of instrument based on the
securities. In technical terms, p-note is a derivative. It derives its value
from the value of underlying securities. In this case, Infosys shares. Any
dividends or capital gains collected from these underlying securities (Infosys)
is passed on to the overseas investor.
These notes allow foreign high net worth
individuals, hedge funds and other investors to put money in Indian markets
without being registered with SEBI, thus making their participation easy and
smooth. P-Notes also aid in saving time and costs
associated with direct registrations.
Advantages of Participatory Notes:
- Easy Investment Route: Investing through P-Notes is very simple and
hence very popular amongst FIIs. Overseas investors need not be registered
with SEBI & go through a lot of scrutiny, such as know-your-customer
norms, before investing in Indian shares.
- Anonimity: Also, since the end beneficiary of these notes is not
disclosed, many investors who want to remain anonymous use it.
- Easer of Trading: Trading
through participatory notes is easy because they are like contract notes
transferable by endorsement and delivery.
- Tax
saving: Some of the entities route their investment through
participatory notes to take advantage of the tax laws of certain preferred
countries.
Disadvantages of P-notes:
The primary reason why P-Notes are worrying is
because of the anonymous nature of the instrument as these investors could be
beyond the reach of Indian regulators. Further, there is a view that it is
being used in money laundering with wealthy Indians, like the promoters of
companies, using it to bring back unaccounted funds and to manipulate their
stock prices.
Recent histiory of P-Notes :
- In november 2019, SEBI issued new guidelines. according to the guidelines
foreign portfolio investors (FPI) would have to make separate
registrations for issuing p-notes for underlying derivatives. However,
this requirement is waived for p-notes against underlying cash equities.
- In 2017, SEBI came out with guidelines for issuance of
such instruments where the underlying assets are derivatives. as per the
guidelines participatory notes or Offshore Derivative Instruments (ODIs)
where the derivative is underlying can be issued only for the purpose of
hedging with respect to the equity shares held. The ODI issuing FPIs shall not be allowed to issue ODIs
with derivative as underlying, with the exception of those derivative
positions that are taken by the ODI-issuing FPI for hedging the equity
shares held by it, on a one to one basis. The existing p-notes on
derivatives will have to be liquidated by december 2020 when it will be
completely phased out.
- In 2007, P-Notes
were banned for a while due to a surge in capital flows and excess
liquidity. After this, markets crashed immediately, but recovered after
the regulator said FIIs could not take any fresh exposure, and their
existing investments would have to be wound up in 18 months. But a year
later, all restrictions on P-Notes were removed during the financial
crisis, only to be tightened again later.
- in 2006, Sebi issued stricter KYC, disclosure regime for
P-Notes. Under the new norms, all the
users of ODIs would have to follow Indian KYC and AML (Anti Money
Laundering) Regulations, irrespective of their jurisdictions, while the
ODI issuers will be required to file suspicious transaction reports, if
any, with the Indian Financial Intelligence Unit, in relation to the ODIs
issued by them
- In 2017, Foreign institutional investors (FPIs) issuing
participatory notes (P-notes) have decided to impose a 7.5 per cent tax on
those who want to use these off-shore derivative instruments to bet on
India’s equity market
Due to SEBI's strengthening of the regulatory framework for
P-notes and other factors, their investments fell to a record low of ₹1.25
trillion (equivalent to ₹1.4 trillion or US$20 billion in 2019). The amount of
foreign portfolio investments (FPIs) via P-notes decreased from a high of 55%
to 4.1% between October 2007 and August 2017
For latest DATA on participatory notes click the link below:
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