EconomyGeneral Studies III



Participatory notes of Overseas Derivative Instruments have a tendency to raise the hackles of the regulators.

  • Outstanding P-notes hitting a 31-month high in November is likely to have caused considerable consternation.

What is P-Note:

  • participatory note, commonly known as a P-note or PN,
  • It is an instrument issued by a registered foreign institutional investor (FII) to an overseas investor who wishes to invest in Indian stock markets without registering themselves with the market regulator, the Securities and Exchange Board of India (SEBI).
  • SEBI permitted foreign institutional investors to register and participate in the Indian stock market in 1992.
  • These notes are a unique Indian invention started in 2000 by SEBI to enable foreign corporates and high networth investors enter the Indian market without having to go through the process of registering as Foreign Institutional Investor (FII).

How the money flows in P-Notes?

The investors, who buy P-Notes, deposit their funds in the US or European operations of the FII, which also operates in India. The FII then uses its proprietary account to buy stocks in India. For example, a P-Note on Infosys or RIL can be issued by an FII or a foreign brokerage in say Mauritius to one of its clients there or from some other country. Equity-linked notes, capped return note, participatory return notes and investment notes are examples of some kinds of P-notes.

What is the major feature, which makes P-notes useful for investors?

One of the main features of the P-notes is that they conceal the investor’s identity. While one reason for using P-Notes is to keep the investor’s name anonymous, some investors have used the instrument to save on transaction costs also. Such investors look for derivative solution to gain exposure in individual, or a basket of, stocks in the relevant market. Sometimes, investors enter the Indian markets in a small way using P-Notes, and when their positions become larger, they find it advantageous to shift over to a full-fledged FII structure.

What is role of P-notes in Indian Economy?

Participatory notes (PNs) are instruments issued by SEBI- registered foreign institutions to entities that want to invest in Indian markets but do not want to directly register with the market, resulting in concealment of the investor’s identity. About 45 percent of total investments made by foreign instructional investors (FIIs) are through the P-notes. In the past, whenever the government has tried to control inflows through P-notes, it has faced strong opposition from FIIs. The ban of PNs has the capacity to erode the grains in shares of the past three years.

Advantages of participatory notes

The participatory notes play an important role in the Indian Economy. About 45 % of the total investments are made through the participatory notes by the foreign instructional investors (FIIs). P-Notes also helps in keeping the investor’s name anonymous along with reducing the transaction costs. Some of the major advantages of participatory notes are as follows:

  1. Any entity can invest in the participatory notes without registering under SEBI while registering under SEBI is compulsory for all FIIs. PNs also enable the large hedge funds to continue their operations without disclosing their identity.
  2. Participatory notes are transferable through endorsement and delivery making trading easy in the country.
  3. Some of the entities route their investment through participatory notes to take advantage of the tax laws of certain preferred countries.

What are Disadvantages of P-notes?

P-notes where they provide a big kitty of advantages for anonymous overseas investors are a source of worry to SEBI as they have become an easy route for money laundering i.e. aid in movement of black money or unaccounted transactions. This is because, it is difficult to establish the beneficial ownership or the identity of the ultimate investor, and hence cannot be taxed. It is feared that FIIs, which have to comply with the know your customer norms, know the identity of the investor to whom P-Notes are issued. But it is possible for the investor to sell the P-note to another player resulting in multi-layering. Tax officials also fear that P-Notes are increasingly becoming a favourite among a host of Indian money launderers, who use the instrument to first take funds out of the country through the hawala route, and then get it back using P-Notes.

SEBI Norms on P-Notes

As they are issued outside India, so cannot be regulated. The anonymity clause further paralyses the market regulator to get to the real investor in case of any illegal transaction. SEBI has thus introduced new norms under which all P-notes will have to abide by Foreign Portfolio Investors Regulations. Further on, these won’t be allowed to be issued by a resident of a country identified by Financial Action Task Force as a “jurisdiction having a strategic Anti Money Laundering or Combating the Financing of Terrorism deficiencies to which counter measures apply. Likewise many more checkpoints have been laid down to effective control over the investment. Total investments via P-notes stood at $43 billion in October 2014.

What are FIIs?

Foreign Institutional investors (FIIs) are the entities established outside India that are responsible for making investment proposals in India. They play an important role in the economy of a country.  There are over 1450 FIIs registered under the Securities and Exchange Board of India (SEBI).

During 1996-97, the following changes were made in the SEBI Regulations, 1995 to facilitate the inflow of foreign portfolio investment:

  • Each of the Foreign Institutional investors can now invest up to 10% of the equity of any one company, subject to the overall limit of 24% on investments by all FIIs, NRIs and OCBs.
  • The FIIs have been permitted to invest 100% of their portfolios in debt securities under the approval of SEBI.
  • The FIIs that are eligible under SEBI are permitted to include the endowments, university funds, foundations, charitable trusts and societies registered with a statutory authority of their country and having a track record of 5 years.

Source: Business Line

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