PARTICIPATORY NOTES PARTICIPATORY NOTES

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Yogesh DubeyYogesh Dubey

MEANING MEANING Participatory Notes or P-Notes are financial instruments

that are issued by FII’s to investors and hedge funds who wish to invest in Indian stock markets, but who are not registered with SEBI (Securities and Exchange Board of India).

Other name of P note is offshore derivative instruments.

What is In your mind?What is In your mind?

What is an FII?

What are hedge funds?

Why P-Notes?

How does it work ?

Who gets P-Notes?

Who can invest in P-notes?

What is an FII?What is an FII?

An FII, or a foreign institutional investor, is an entity established to make investments in India

However, these FIIs need to get registered with the Securities and Exchange Board of India

SEBI’s definition of FIIs SEBI’s definition of FIIs presently includes:presently includes:

Pension Funds Mutual Funds Investment Trust Insurance or reinsurance companies Endowment Funds, University Funds Asset Management Companies Nominee Companies Institutional Portfolio Managers

Contd.Contd.

Trustees Banks It also includes asset management companies and other

money managers operating on their behalf.

Why P-Notes ?Why P-Notes ?

Since international access to the Indian capital market is limited to FIIs, The market has found a way to circumvent this by creating the device called Participatory Notes, which account for half the $80 billion that stands to the credit of FIIs. Investing through P-Notes is very simple and hence very popular

MEANING MEANING Participatory Notes or P-Notes are financial instruments

that are issued by FII’s to investors and hedge funds who wish to invest in Indian stock markets, but who are not registered with SEBI (Securities and Exchange Board of India).

Other name of P note is offshore derivative instruments.

Who gets P-Notes ?Who gets P-Notes ?

P-Notes are issued to the real investors on the basis of

stocks purchased by the FII. The registered FII looks after

all the transactions, which appear as proprietary trades in its

books.

It is not obligatory for the FIIs to disclose their client details

to the Sebi, unless asked specifically.

Morgan Stanley , Citigroup ,Goldman Sachs, Macquarie

and Standard Chartered Bank who are registered in India

with SEBI issue Participatory Notes.

Advantages of P-Notes Advantages of P-Notes

Convenient for foreign investors, because participatory

notes are like contract notes transferable by approval

P-note provide high degree of anonymity.

Some of the entities want their investment through P notes to

take advantage of the tax laws of certain preferred

countries.

It is important source of investment in Indian capital market

It strengthen rupee against the dollar.

Who can invest in P-notes?Who can invest in P-notes?

Any entity incorporated in a jurisdiction that requires filing of

constitutional and/or other documents with a registrar of

companies

Any entity that is regulated, authorised or supervised by a

central bank

Any entity that is regulated, authorised or supervised by a

securities and exchange board, such as the Securities and

Exchange Commission.

Cont…….Cont…….

Any entity that is a member of securities or futures exchanges such as the New York Stock Exchange (Sub-account), London Stock Exchange (UK).

Any individual or entity (such as fund, trust, collective investment scheme, Investment Company or limited partnership) whose investment advisory function is managed by an entity satisfying the criteria of above.

How does it work ?How does it work ?

FIIs who issue/renew/cancel/redeem P-Notes, are required to report on a monthly basis.

The FII merely investing/subscribing in/to the Participatory Note or any such type of instruments/securities with underlying Indian market securities are required to report on quarterly basis (Jan-Mar, Apr-Jun, Jul-Sep and Oct-Dec)

FIIs who do not issue PNs but have trades/holds Indian securities during the reporting quarter (Jan-Mar, Apr-Jun, Jul-Sep and Oct-Dec) require to submit 'Nil' undertaking on a quarterly basis

Role of P-notes in Indian security Role of P-notes in Indian security market market

Huge inflow of foreign funds into Indian stock market

The contribution of participatory notes in 2003 was estimated

to be $ 1.5 billion and approx $ 9 bn in 2009

P-Notes accounted for as much as 55% or more than half of

total inflow into India in 2009.

After GAAR ProposalAfter GAAR Proposal

• Overseas entities, investing in Indian markets through 'Participatory Notes', are estimated to have pulled out over Rs 1 lakh crore (about USD 20 billion) in less than three months on fears of getting caught in the government's taxation net and its black money trail.

As a result, the quantum of money invested through these P-Notes has hit its rock-bottom levels of just about 10 per cent of total FII (foreign institutional investment) holdings, which used to be more than 50 per cent a few years ago

Whether participatory note be Whether participatory note be abolished?abolished? It gives rise to illegal activities. As it is associated with

Benami transaction which is not allowed in Indian stock market

Leaves no Trail. Front door closed but back entry is possible. P-note creates a mirage that the market is booming Highly moving money (increases volatility)

Caution!!!Caution!!!

We have to be realistic P-Notes constitute a substantial part of FII net inflow

(around 30-40%) In a time when GDP growth rate slumped to 9 year low,

CAD (Current Account Deficit) is at all time high at 4.3% of GDP, country need every bit of foreign investment.

Govt is not in a position to move forward with the decision.

Participatory Notes Crisis of 2007Participatory Notes Crisis of 2007

P-notes crisis took place on 16th of October, 2007

proposals of SEBI were not clear and this led to a knee-jerk

crash

Sensex crashed by 1744 points in a single day.

P.Chidambaram issued clarifications, that the government

was not against FIIs and was not immediately banning PNs

Recent developmentsRecent developments

On last Thursday CBDT issued draft guidelines for GAAR implementation.

GAAR provisions will not be invoked if FII presents itself to taxation under domestic law.

Non resident investors will certainly be out of the net. Protects the revenue interest in the sense that provisions can

be invoked against an FII if it fails to substantiate the substance in jurisdiction and transaction.

Suggestions Suggestions

Allow some time for transition to FIIs. Specify new norms, rules and procedures for issuance of

PNs. Restrict PNs to a certain threshold level of total FII

inflow(15-20%)