Amid concerns over possible misuse of always-in-controversy P-Notes, mutual funds have emerged as the top users of these offshore instruments for investing in Indian markets with a share of over 60 per cent.
Besides, just ten foreign portfolio investors account for almost 73 per cent of total outstanding investments worth over Rs 2.2 lakh crore through the Offshore Derivative Instruments — commonly known in India as Participatory Notes or P-Notes.
These FPIs include Singapore and Mauritius-based arms of global giants like Morgan Stanley, Goldman Sachs, Credit Suisse, HSBC, Merrill Lynch, Citigroup and JP Morgan.
Markets regulator Sebi (Securities and Exchange Board of India) has decided to tighten the due-diligence norms for issuance and transfer of ODIs after concerns were raised by the Supreme Court-appointed Special Investment Team (SIT) on Black Money about the possible misuse of these instruments for laundering of black money or round tripping of funds.
While foreign investors can register themselves as FPIs to invest directly in India, ODIs are typically market-access instruments preferred by those looking to save on time and operational costs involved with a direct registration.
Sebi rules allow certain classes of FPIs to issue ODIs after a proper due-diligence process that has been further tightened now to address the concerns raised by the SIT.
The regulator has also collected information for the SIT from the ODI issuers about the number of ODI subscribers in various categories along with their outstanding investment.
Out of a total of nearly 2,500 entities that are subscribing to ODIs, nearly 1,500 (over 60 per cent) are mutual funds and about 300 others are ‘companies’.
Other ODI users included over 50 ‘Trusts’, nearly 100 banks, over 50 sovereign wealth funds, over 200 hedge funds and 60 pension funds. There are also some university funds, endowment funds and charitable societies or foundations.
The ODI issuers informed Sebi that they do not issue these instruments to individuals at all.
According to Sebi, there are 37 FPIs which are issuing ODIs and these include “global banks and securities houses which issue ODIs all over the world and have well established infrastructure — both physical and technological — and documentation programmes in place which are used for global jurisdictions and offer their services in markets globally”.
An analysis of reports filed by the ODI issuers with Sebi further showed that the top-ten locations where end beneficial owner of FDIs was located together accounted for nearly 93 per cent of total outstanding ODIs.
Top on the list is Cayman Islands (over 41 per cent), followed by Mauritius, the UK and the US with nearly 11 per cent share each in the total outstanding ODIs. Also in the top-ten locations were Ireland, France, Luxembourg, Singapore, British Virgin Islands and South Korea with 1-6 per cent share each.
Of these 37 ODI-issuing FPIs, the top-ten accounted for nearly 73 per cent of the total outstanding ODIs, which stood at Rs 2,23,077 crore as on March 31, 2016 or about 10 per cent of the total asset under custody of all FPIs registered in India.
This ratio has come down significantly from over 55 per cent at the peak of bull run in Indian stock market in 2007.
Top on the list was Morgan Stanley Asia (Singapore) Pte with nearly 14 per cent share in the total outstanding ODIs, followed by Copthall Mauritius Investment Ltd (nearly 12 per cent), Goldman Sachs (Singapore) Pte (over 9 per cent), Credit Suisse (Singapore) Ltd (nearly 7 per cent) and HSBC Bank (Mauritius) Ltd (over 6 per cent).
Also in the top-ten were Merrill Lynch Capital Markets Espana of Spain, Citigroup Global Markets Mauritius, Swiss Financial Corp (Mauritius), JPMorgan Chase Bank, National Association (USA) and Citicorp Investment Bank of Singapore with 4-6 per cent share each.
While there are apprehensions that the stricter set of norms will make it costlier to invest in India through P-Notes as one of the major attractions of such instrument is cost-effectiveness and easier access, most of the ODI issuers consulted by Sebi have agreed to a majority of new measures being put in place to check any misuse.
Apart from the requirement of reporting about positions of ODIs, the issuers would be now required to provide further details about the end beneficial owner and comply with onshore KYC norms.
The latest changes would make the regulatory framework in India more stringent than many developed and developing nations.
Rules have been tightened several times in recent years to check any misuse of this route, but P-Notes have still continued to court controversies.
These instruments are in vogue in various other markets by different names such as Equity Linked Notes, Capped Return Notes, Total Return Swaps, Participating Return Swaps, Credit Linked Loan, Equity Linked Certificates.
ODIs are issued by an FPI overseas as market access products against securities held by it that are listed or are proposed to be listed on a stock exchange in India, as its underlying. These underlying securities can be equity, debt, derivatives, index, a basket of securities from different jurisdictions with a portion being Indian securities or indices, or a basket of Indian securities.
The ODIs include over-the-counter derivatives documented through a bilateral contract, as also the securitised instruments such as notes, certificates or warrants.