Home / Market / Stock-market-news /  Sebi norms will gradually make P-Notes irrelevant

Mumbai:Nearly one year after a Supreme Court-appointed special investigation team (SIT) called for checks on participatory notes (P-Notes), the capital markets regulator is starting to implement the recommendation.

The Securities and Exchange Board of India (Sebi) on Thursday unveiled new norms for P-Notes which, while ensuring more transparency, will also gradually make the product irrelevant.

Sebi’s strategy seems to be to avoid a complete clampdown on P-Notes, but make the product less attractive.

The market watchdog proposed an increase in disclosure needs and restricted the transfer of P-Notes, which will be allowed only after the consent of the issuer and only to investors on a pre-approved list. The issuer will also need to report who controls the management and operations of a P-Note subscriber.

The initial verdict on the Street is that Sebi’s steps may not result in a knee-jerk reaction in the market, but in the long term, money coming through this route may be affected as the responsibility for compliance is largely laid on the P-Note issuers/financial institutions.

On Friday, the BSE’s benchmark Sensex fell 0.4% to 25,301.90 points.

P-Notes are instruments issued by registered foreign portfolio investors (FPIs) to overseas investors, who wish to invest in the Indian stock market without registering themselves with the market regulator.

They are popular as they allow the investor’s identity to be kept anonymous.

P-Notes are seen as an opaque route for investment which leaves room for round-tripping—the practice of money stashed away overseas by Indians returning home through tax havens in the garb of foreign capital—and money laundering.

From the time they were introduced in 1995, the government has been seeking to regulate them. The Reserve Bank of India (RBI) has been against the idea of P-Notes, raising concern on the hidden identities of investors and “multi-layering", which makes it impossible to know the actual beneficiaries.

Whenever there was an attempt to curb flows by tightening P-Note norms, markets have fallen, preventing the execution of harsh measures. A crackdown was attempted in 2007 when a phasing out of P-Notes was sought. Then, P-Notes accounted for over 50% of total foreign holdings. The result: a drop of around 10% within minutes of market opening for the first time after the announcement. Trading was halted for an hour. The then finance minister, P. Chidambaram, and the then Sebi chief, M. Damodaran, had to make statements to calm the markets.

Since then, Sebi has adopted a cautious approach towards tightening of regulations. In 2011 and 2014, Sebi said P-notes can be issued only to investors coming from jurisdictions that have anti-terror funding norms and anti-money laundering norms.

Subsequently, Sebi also took steps to track beneficiaries and make it easier for foreign investors to register with the regulator and avoid the P-Note route.

The Supreme Court-appointed SIT found these curbs were not enough to pinpoint the ultimate beneficial owner of P-Notes. What followed were recommendations on 25 July 2015 that sought more curbs on P-Notes, particularly clamping down on transfer of P-Notes, a big draw for the product.

Fearing another clampdown by the government, the market dropped by about 2% when the report was made public.

To avoid that, a year later, the market watchdog has taken a more pragmatic approach—increasing checks and balances on P-Notes without suggesting any immediate clampdown.

Over time though, these norms may ensure that P-Notes, which now contribute around 10% of the total foreign portfolio investment flows, may slowly become irrelevant due to the heightened compliance requirements.

“These changes will not only make the route difficult to access the India market but also make it more expensive. ODI (offshore derivative instrument) issuers will have to put in place a robust mechanism to track end-beneficial owner," said Suresh Swamy, who oversees tax and regulatory (financial services) practice at PricewaterhouseCoopers India.

Many foreign banks and FPI custodians say the flow could reduce to around 5-6% of the total FPI flows in coming years.

“Over the years, Sebi has stepped up compliances for P-Note issuers; this has contributed to reducing foreign flows through this instrument. These norms may impact the flows in long term and they could be substantially reduced from the 10% notional value," said Swamy.

Richie Sancheti, head, investment funds, Nishith Desai Associates, says the product may still remain relevant.

“The product will still remain relevant for investors who want an Indian exposure with lower overall costs and administrative overheads, including engaging a custodian and filing tax returns in India. P-Notes and other classes of over-the-counter derivatives allow subscribers a streamlined basis for accessing several markets while dealing with very limited number of counter-parties," said Sancheti.

“An FPI (foreign portfolio investor) licence on the other hand remains relevant for participants seeking a deeper India exposure without counter-party intermediation. With the gradual improvement in visibility to end beneficial owners in case of ODIs, the regulators should be comfortable with both formats of market access," he added.


Jayshree P Upadhyay

Jayshree heads a team of reporters focussing on legal, regulatory, investigative stories. She has worked for over a decade, reporting on financial scams, legal stories and the intersection of corporate and regulatory issues. She is based in Mumbai and has previously worked with Business Standard, Mint, The Morning Context and Bloomberg TV India.
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