Participatory note

 A participatory note, also known as a P-note, that is an instrument issued by a registered foreign institutional investor (FII) to an overseas investor who wishes to invest in Indian stock markets without registering themselves with the market regulator.

Securities and Exchange Board of India (SEBI) permitted foreign institutional investors to register and participate in the Indian stock market in 1992. 

Investing through participatory-notes is very simple, and very popular amongst foreign institutional investors.

P-Notes are among the group of investments considered to be as Offshore Derivative Investments (ODIs).

Who issues P- Notes and what is the process?

Participatory notes are issued by brokers and FIIs registered with SEBI. The investment is made on behalf of these foreign investors by the already registered brokers in India.

For example, Indian-based brokerages buy India-based securities and then issue participatory notes to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investors.

The brokers that issue these notes or trades in Indian securities have to mandatorily report their PN issuance status to SEBI for each quarter. These notes allow foreign high networth individuals, hedge funds and other investors to put money in Indian markets without being registered with SEBI, thus making their participation easy and smooth.

Why participatory notes are popular among the foreign investors?

Participatory notes are largely used by foreign investors who do not want to or cannot access Indian markets directly.

This could be either because they want to avoid the rigmarole and the cost of registering with another regulator, or because of restrictions in their investment mandates.

Some investors also like to use P-Notes because of the flexibility they provide.

P-Note issuers are known to issue over-the-counter derivatives products that are customised to their customers’ needs.

This could be a put option for a tenure that is not readily available in Indian markets, or an exposure to an index that is not traded, or something far more exotic.

To the extent that such products are not available in the onshore markets, there will always be a demand for such structured products in the form of P-Notes.

Advantages of participatory notes

The participatory notes play an important role in the Indian Economy. About 45 % of the total investments are made through the participatory notes by the foreign instructional investors (FIIs). 

P-Notes also helps in keeping the investor’s name anonymous along with reducing the transaction costs.

Any entity investing in participatory notes is not required to register with SEBI, whereas all FIIs have to compulsorily get registered. It enables large hedge funds to carry out their operations without disclosing their identity.

Trading through participatory notes is easy because they are like contract notes transferable by endorsement and delivery.

Some of the entities route their investment through participatory notes to take advantage of the tax laws of certain preferred countries.

Disadvantages of participatory notes

Because of the anonymous nature of the instrument, the investors could be beyond the reach of Indian regulators. Aid in movement of black money or unaccounted transactions.

P- Notes are being used in money laundering with wealthy Indians, like the promoters of companies, using it to bring back unaccounted funds and to manipulate their stock prices.

It is difficult to establish the beneficial ownership or the identity of the ultimate investor, and hence cannot be taxed.

It is feared that FIIs, which have to comply with the “know your customer” norms, know the identity of the investor to whom P-Notes are issued. But it is possible for the investor to sell the P-note to another player resulting in multi-layering.

Tax officials also fear that P-Notes are increasingly becoming a favourite among a host of Indian money launderers, who use the instrument to first take funds out of the country through the hawala route, and then get it back using P-Notes.

 What are government & regulator’s concerns?

The primary reason is anonymous nature of the instrument as these investors could be beyond the reach of Indian regulators.

Further, there is a view that it is being used in money laundering with wealthy Indians, like the promoters of companies, using it to bring back unaccounted funds and to manipulate their stock prices.