Mumbai: To track possible illegal money coming into India, the capital market regulator wants foreign institutional investors (FIIs) to name upfront the beneficiaries of participatory notes, or P-notes, and other offshore derivative instruments (ODIs).
The move will not only make FII transactions more transparent but will also significantly reduce the time taken by authorities to trace nefarious fund transactions affecting Indian markets, said a government official involved in discussions with the regulator.
P-notes are instruments that derive value from an underlying financial instrument such as an equity share. Overseas investors and hedge funds use these to anonymously invest in Indian securities through FIIs registered with the Securities and Exchange Board of India (Sebi).
“Sebi has all along been concerned about the identities of P-note beneficiaries, but the government’s determination to expose black money has prompted the regulator to do this,” said another person, who is involved in discussions between Sebi and FIIs. “This particular move will plug all major loopholes in the P-note regulations and make it difficult for FIIs to circumvent rules.” Both the persons declined to be named.
Sebi had last month directed FIIs to disclose the country of the end-owners of ODIs.
If an ODI is hedged with multiple Indian securities and left partly unhedged, the value of ODIs for each Indian security as well as the unhedged portion has to be reported separately, it said in mid-June.
FIIs will have to establish the linkages for all outstanding ODI positions as on 30 September. They need to disclose such transactions by March, the regulator has directed.
Assets worth at least Rs 10.86 trillion are held in the custody of FIIs, according to Sebi, of which at least 19% was held through P-notes in May.
A number of Indians could be holding black money worth at least $1 trillion in various overseas banks, according to media reports.
The whole debate has been over the quality of money flowing into India, said a partner with a Mumbai-based corporate law firm. He spoke on the condition that neither he nor his firm be named as it has many FII clients.
The reason behind the popularity of P-notes is that such contracts are easily transferable and they help investors take advantage of the tax treaties between India and other countries.
Sebi started the process of disclosure in 2004 by asking FIIs to maintain details of all P-note holders and provide them to the regulator when demanded.
FIIs currently maintain the records of all P-note beneficiaries with their global custodians outside India. When Sebi receives complaint on a particular FII activity or suspects foul play, it demands the identities of the P-note holders for investigations.
Sebi now wants details of all end-beneficiaries upfront on a regular basis.
“This will significantly help Sebi establish linkages of all fund transactions and scrutinize if any rule has been violated,” said an official with a registered FII, who also spoke on condition of anonymity.
In October 2007, Sebi imposed curbs on P-notes, which accounted for nearly 50% of FII assets in India then. The Indian markets tanked following this, with the 30-share bellwether index of Bombay Stock Exchange, the Sensex, crashing by 1,744 points, or about 9% of its value, recording one of the biggest intra-day falls in Indian stock markets.
Since then, P-note transactions have come down and now range between 14% and 20% of FII assets.
Several FIIs have faced Sebi action after failing to provide details of end beneficiaries of ODIs issued by them.
In January 2010, Sebi had barred Societe Generale from issuing ODIs for failing to provide true, fair and complete details of its activities and possible violations of FII norms by furnishing false information. Before that, in December 2009, Barclays Bank was suspended from issuing such instruments for similar reasons. The bans were later lifted.
A wealth management official at a large US brokerage said Sebi “may need to do more” to identify the exact identities of end beneficiaries. “The recent move will only reveal the custodian bank accounts but not the name of the accountholders who have parked the money,” he said. “The banks may not reveal the names of accountholders, citing country regulations.”
A Mumbai-based consultant on FII regulations said Sebi’s move will prevent insider trading by Indian promoters who route investments through ODIs. Both the official and the consultant requested anonymity.
There are 1,729 FIIs in India and their 5,912 sub-accounts are registered with Sebi.
FIIs bought Indian stocks worth $2.09 billion so far this year net of selling after pumping in a record $29.36 billion in 2010.