The new participatory note regime

The new participatory note regime: How will the market react?

February 9, 2015, 4:43 PM IST Economic Times in ET Commentary | Business, India, Markets | ET

The Securities Exchange Board of India’s latest circular on overseas direct investment (‘ODI’) / participatory notes (‘P-notes’) marks another step by the Indian Government to curb money laundering by imposing tight norms for foreign investors accessing Indian markets. P-notes have always been a preferred option for overseas investors who want to have easy access to Indian markets without formally being compliant with Indian regulations. P-notes help them avoid time, cost and procedural issues associated with SEBI registration, making investment simple and attractive. Given this fact, the current regulations have resulted in rules that may not be welcomed by many P-notes investors. markets-up-bccl

This article summarises the changes brought by the regulations and issues that may arise for both P-note participants as well as P-note issuers.

1. Narrowed the set of countries for P-note participants – They have to be compliant with both IOSCO and FATF, which is the

anti-money laundering international body. Furthermore, they cannot be issued to opaque structures

2. Investors caught on both the legs –The investment restrictions imposed are like double edged sword. They not only consider

two P-note holders having a common beneficial owner as one holder, but also consider clubs’ P-note holdings with foreign

portfolio investors (‘FPI’) for calculating investment limits.

3. Investment restrictions resulting in switching from one FPI to another- FPI and positions held as P-notes will now be clubbed together for meeting the investment criteria of 10% per FPI. This would mean that P-note holders whose current holding after clubbing with FPI has exceeded 10% will now have to unwind their investment to meet the norms or else they will have to move to another FPI which has the bandwidth to accommodate them. This also means FPIs will now have to keep a tab on their investment limits and may also have to stop if the norms are crossed. From a P-notes perspective, every time an investor wish to invest, they will first have to check whether the FPI has the bandwidth to accommodate them, or else they will have to search for another FPI. Investors have always been attracted to P-notes only for their ease in accessibility and this move hampers this

completely.

4. The burden of disclosures – The onus of ensuring compliance by P-notes is on the FPIs, which in turn implies that they may resort to taking necessary undertakings / disclosures, etc. from the investors or follow certain other procedures . This may work in the same manner as the way FPIs discloses information to their designated depository participants (‘DDP’). This is a big

hindrance as P-notes participants always wanted to do away with disclosure norms.

5. Ambiguity on disclosure requirements – In a situation where two ODIs have common a beneficial owner and have to club for investment restrictions, it is not clear where they would report the

disclosure requirements. FPIs have DDP in place to report their disclosures to, but P-note holders do not have DDP and hence, clarity is required in this connection. The above move of SEBI comes at a time where the domestic market is experiencing a steady rise in P-notes since July. The value of outstanding investments in P-notes into India’s capital market stood at 2.66 trillion at the end of October, the seventh highest level in almost seven years. The budget speech of Honorable Finance Minister early this year laid out two objectives of the Indian Government i.e. liberalising regulatory norms for foreign investors in order to boost foreign investment in India and the curbing of black money from flowing in the economy . This move of SEBI aligns with its second objective; however the boosting of foreign investment may not fully materialise with the current regulations. We believe that the government needs to take a balanced approach in handling the foreign investors so that the inflow of foreign capital is not obstructed and at the same time there is no misuse of such structures for round tripping and money laundering.

(The authors are Partner, PwC India and Senior Manager, PwC India, respectively.)