Over the last 6 months, Participatory notes (‘P notes’) have taken a fair share of media space. Initially, it was the Sebi clampdown and recently it is the tax issue. P-note seems to start sounding like a problematic note rather than a participatory note.
What exactly are p-notes and why so much of fuss? P-notes are essentially offshore derivative instruments (‘ODIs’), issued to overseas investors by registered foreign institutional investors (‘FII’). These instruments derive their value from the ownership of underlying shares in an Indian company. ODIs include P-notes, equity linked notes, capped return notes, participatory return notes, invest notes, etc. In the Indian context, P-notes and ODIs are used interchangeably.
It is a convenient, though expensive, route for foreign investors to take exposure to Indian securities without taking the trouble of registering with the market regulators. In some cases these investors may be forced to take this route as Indian regulators may not grant registration, though the investor may be willing to register (eg Hedge funds are not granted FII registration as they are not regulated in their home country). In such cases, the registered FII act as an exchange since it executes trade and uses its internal account to settle this.
Sebi, however, requires the FII to ensure that there is no further downstream issue or transfer of any P-notes to any person other than a regulated entity. FIIs are also required to file monthly reports with Sebi, which provides the details of the name and type of investor to whom P-notes have been issued.
It seems that Sebi is not very happy about P-notes because it does not have any system to know who owns the underlying securities and that it is concerned that non-resident Indians may be using the P-note route and round tripping investments into India. Sebi also fears that hedge funds acting through the P-notes route may cause economic volatility in India’s exchanges. In view of the above apprehensions, there was a major clampdown of the P-notes in October 2007. The recent media reports suggest that Sebi is reviewing its stand on P-notes and is