New Delhi: The Securities and Exchange Board of India (Sebi) proposes to levy a $1,000 fee on foreign portfolio investors (FPIs) for each participatory note (P-Note) issuance in an effort to cut down on speculative investments.

In a consultation paper released on Monday, the markets regulator also proposed banning P-Notes that are based on derivatives used purely for speculative purposes.

P-Notes, or offshore derivative instruments (ODIs), are issued by registered FPIs to overseas investors who wish to invest in Indian stock markets without registering themselves with Sebi.

The value of such instruments stood at Rs1.68 trillion at the end of April, about 6% of total foreign investments in Indian stocks and equity derivatives.

Owing to their opaque nature, P-Notes have long been perceived as a conduit for black money.

Sebi’s proposed $1,000 fee will be levied every three years for every P-Note issuance, according to the discussion paper. This means that if an FPI issues a P-Note to five different investors, it has to pay $5,000 in fees.

“We understand from monthly ODI data reported by the ODI issuers that quite a few ODI subscribers invest through multiple issuers. It will discourage the ODI subscribers from taking ODI route and encourage them to directly take registration as an FPI," said the Sebi circular.

“The regulatory fee of $1,000 will reduce the arbitrage opportunity that currently the ODI subscribers enjoy while investing in the Indian markets," said Sandeep Parekh, founder, Finsec Law Advisors.

In its discussion paper, Sebi has also suggested that investors wind down their speculative positions using P-Notes by 2020.

The regulator has invited comments from the market till 12 June.

“It will be incumbent on ODI issuing FPI to ensure that ODI is issued against those derivatives which are purely for hedging purpose and not for naked speculation," said the Sebi discussion paper.

The government and the market regulator have been steadily tightening their regulations around ODIs to promote direct registration through the FPI route in a bid to curb the shadow economy.

In May 2016, Sebi had increased disclosure requirements and restricted transfer of ODIs. In a board meeting on 26 April, Sebi had also proposed that P-Notes not be issued to non-resident Indians .

“If the proposed norms are implemented in the current format, it will have some impact on ODI issuances. But it may be not that material as derivatives are a smaller portion of overall ODIs. However, this, coupled with regulatory fee, will promote more FPI registration," said Tejesh Chitlangi, a partner at law firm IC Legal.

Once accounting for up to 50% of all foreign investments, P-Note issues have fallen significantly. According to the Sebi website, P-Notes issued against derivatives stood at Rs40,165 crore, or about a quarter of all ODIs.

While it seems a small number, the proposal will impact “all the derivatives positions of ODI subscribers. Most of these ODI subscribers trading in derivatives are naked speculators," said Bhavin Shah, partner and leader (financial services and tax) at consultancy PwC. Naked speculators are ODI subscribers who enter the Indian markets to trade in the futures and options segment.

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