Investments made by foreign funds via the participatory notes (P-Notes) route significantly decreased in the last decade as the Securities & Exchange Board of India (Sebi) tightened regulations on foreign portfolio investors (FPIs).
P-Notes currently account for about 20% of the total FPI inflows, against 50% in 2007. In absolute terms, investments made through P-Notes during January 2016 was Rs 2.31 lakh crore, compared with Rs 4.5 lakh crore in January 2007, Sebi data showed.
The markets regulator tweaked FPI regulations in January 2014. In order to check money laundering through P-Notes, Sebi barred unregulated foreign funds from dealing in offshore derivative instruments even if their investment managers are appropriately regulated by regulators concerned. These guidelines provided stricter oversight on P-Notes – which was then the preferred route for overseas high net worth individuals (HNIs) and hedge funds for investing in the Indian markets.
During the recent interaction with media, Sebi chairman UK Sinha noted that concerns over P-Notes being misused to bring black money back into the country were put to rest. “Sufficient safeguards have been put in place to check any possible gaps and Sebi is now in a position to identify and check details of beneficiary owners of such funds to the second, third and even fourth levels,” Sinha said.
Market participants said foreign funds these days prefer taking the direct route for investing in the Indian markets as regulations for direct investments have become much easier. “Good progress has been made in terms of easing norms for foreign investors. Currently, the taxation policy for FPIs is much clear and has little scope for litigation. Even the issue regarding Minimum Alternate Tax (MAT) has also been resolved,” said a consultant at Ernst & Young.
P-Notes or offshore derivative instruments are mostly used by overseas HNIs, hedge funds and other foreign institutions to invest in Indian markets through registered FPIs. The process saves time and costs associated with direct registrations.
As per the new FPI regime, foreign funds have been divided into three groups based on their risk profile. Category-I FPIs, entities with the lowest risk, include foreign governments and government-related foreign investors. Category-II FPIs include appropriately regulated broad-based funds, university funds, and university-related endowments and pension funds, among others. Category-III FPIs include all others not eligible under the first two categories.