Participatory Notes

Capital Market regulator SEBI has tightened norms for the issue of Participatory Notes(P-notes) in May,2016. Increase in Compliance and disclosure requirements are proposed, which are aimed to make offshore derivative market more transparent and difficult to route money illegally to Dalal street and round tripping of investments by Indian promoters and parking of black money.

Confused by too much jargons? Well, this blog is an attempt to demystify the concept of P-notes and explain the concerns of all stakeholders in a P-note transaction.


So, what are P-notes?

According to Investopedia, “P –Notes are financial instruments used by investors or hedge funds that are not registered with the Securities and Exchange Board of India to invest in Indian securities”.

 In other words P-notes are financial instruments(share certificates) that are issued by SEBI-registered FII’s to overseas investors that want to invest in Indian equity instruments but want to avoid hassles and complicated registration process with SEBI and KYC (know your customer ) norms.

Let’s see how P-notes come into existence

FII’s registered with SEBI buys Indian shares. On the basis of this stock-notes are issued to overseas investors,HNIs,fund houses etc. The investment is made on behalf of these foreign investors by the already registered brokers in India.

Any dividends or capital gains collected from the underlying securities go back to the investors. Registered FIIs or P-note issuers have to file their quarterly PN issuance details to SEBI.

What are the advantages of P-notes to investors?

P-notes not only promote investment in Indian markets but also offer several benefits to buyers.

⦁ Anonymity-Up till now-notes holders are not supposed to reveal their identity, KYC details, etc. 

⦁ Ease of trading-No need to register with SEBI. P-notes are like contract notes, transferable by endorsement.

⦁ Tax saving-Money can be routed to tax saving destinations. 

⦁ All the benefits like capital gain or dividend belongs to P- note holder.

What are the concerns of Indian Regulators?

• The major concern for SEBI is the anonymous nature of the instrument. As P-note holder are not supposed to reveal their identity, it can be misused for tax evasion, parking of black money and even terror financing. An ordinary investor has to fulfill several legal requirements like PAN and KYC, but the anonymous nature of P-note makes it discriminatory. Further, the source of the funds is unknown and it may promote money laundering. Government of India's white paper on black money has identified P-notes as one of the routes through which black money transferred outside India comes back through a process called round-tripping. Terror financiers find this route attractive and simple, thus, it is not without basis that the National Security Advisor (NSA) has cautioned against terror-financing through the banking and stock market channels.
• Secondly notes may promote takeover of Indian Companies by Foreign sovereign entities, PE firms or special purpose vehicles. Such an unknown entity may target the local company and create pressure for takeover. They could hold shares in Indian companies without the regulatory knowledge.
• Hedge funds are the main participants in the P note market. They may cause unwanted volatility in the Indian stock market. Such oversees funds are mostly unregulated and may manipulate markets for their unfair pie.

So, why are they in news?

• P-notes were under taxmen’s scanner due to their opaque nature. A Special Investigation Team appointed by Supreme Court Of India suggested that government should obtain details of final holder of P notes and restrict its free transferability. The SIT wants investors' due diligence  or KYC  details to be known to the regulator. 
• In May,2016 SEBI forwarded a proposal to Finance Ministry incorporating the above suggestions along with compliance with Anti money laundering laws .Now, the P note issuers are supposed to submit the KYC details of high risk clients to Financial Intelligence Unit. At a board meeting held on 20 may,2016 SEBI implemented the above suggestions to curb the menace of P-notes. Sebi Chairman U K Sinha said the foreign investors have been "persuaded" with regard to the new changes and they are "willing to accommodate" on proposals made by the regulators.

The Road ahead….

The successful amendment of a dual tax avoidance treaty with Mauritius and a proposed treaty with Singapore, new rules for P-note will clean Indian markets. According to R. Jhunjhunwala there should be no short term effects on Indian markets but it has caused some confusion regarding taxation in the instrument. A clarification is expected on the P note taxation by the concerned authorities. The GAAR is expected to be implemented which will address broader issues on tax evasion.

- Shubham Gupta