This document discusses participatory notes (P-notes), which are financial instruments used by foreign investors to invest in Indian securities markets without registering with the Securities and Exchange Board of India (SEBI). P-notes allow overseas investors to invest through registered foreign institutional investors who purchase underlying Indian assets. Profits and dividends from these underlying assets are passed back to overseas investors. While P-notes provide anonymity, SEBI has sought greater transparency in their use.

1. ( presentation submitted for partial fulfilment of FMRS course Finance Part)
Submitted to Submitted By
Dr. Rituparna Das Amit Agrawal (Roll: 587)
Faculty and Additional Director, Nirmal P. Kapanee (Roll: 604)
Centre for Studies in Shashank Kumar (Roll: 611)
Banking and Finance LL.M (Banking and Finance)
NLU, Jodhpur Batch (2014-15)
NLU Jodhpur

2.  Participatory Notes or P-notes are financial instruments used by foreign investors or
hedge funds to invest in Indian securities, such investors are not registered with
Securities and Exchange Board of India (SEBI).
 Access to the Indian capital market is limited to Foreign Institutional Investors (FII)
registered with SEBI, so the market has thus created a pass through mechanism
through P-notes.
 These financial instruments are issued by FII’s to overseas investors who are not
registered with SEBI, but wish to invest in the Indian stock market.
 The value of P-notes is determined on the basis of the underlying assets so
purchased by the overseas investor. Here the underlying assets are shares listed on
the Indian stock exchange.
 Any dividends or capital gains collected from underlying instruments go back to the
overseas investors via brokerage house based in India.

3. UK based investor
Foreign Broking House
(UK)
Foreign Broking House
(India)
X Shares
Issues P-notes with X shares as underlying asset
Conformation of Shares Purchased
Buy X shares
Buy X
Shares
Buys

4.  Any Overseas investor who is investing in Indian stock market through P-notes is
not required to register with SEBI, but all FII’s have to get registered compulsorily.
 Some overseas investors route their investment through P-notes to take advantage of
the tax laws of certain preferred countries. For example through double tax
avoidance agreements by India with certain countries, capital gains arising from sale
of shares are taxable in the country of residence of the shareholder and not in the
country of residence of the company whose shares have been sold.
 P-notes are popular since they provide greater degree of anonymity thereby enabling
hedge funds to carry out their operations without disclosing their identity. It is not
obligatory for the FII’s to disclose their client details to SEBI unless asked
specifically.

5.  Investors ineligible to apply for FII status.
 choose not to apply for FII status because the participatory
note route is quick and easy.
 investors, some of whom have FII status, to hide their Identity.

6.  Prodigal Money Returning. A large number of politicians/
bureaucrats /business-persons have accumulated wealth
abroad.
 Foreign governments/entities who would like to
acquire/control Indian entities by taking them over
 Terror Financiers

7.  The cost of using participatory notes is higher than going
direct
 the buyer is a captured client of the participatory note issuer
in that it must exit the position through the broker/issuer of
the participatory note.

8.  On the 16th of October, 2007, SEBI (Securities & Exchange Board of
India) proposed curbs on participatory notes which accounted for
roughly 50% of FII investment in 2007.

 SEBI was not happy with P-Notes because it is not possible to know
who owns the underlying securities and hedge funds acting
through PNs might therefore cause volatility in the Indian markets.
 However the proposals of SEBI were not clear and this led to a
knee-jerk crash when the markets opened on the following day
(October 17, 2007). Within a minute of opening trade, the Sensex
crashed by 1744 points or about 9% of its value.

9.  This led to automatic suspension of trade for 1 hour. Finance
Minister P.Chidambaram issued clarifications, in the
meantime, that the government was not against FIIs and was
not immediately banning PNs.
 The SEBI chief, M.Damodaran held an hour-long conference
on the 22nd of October to clear the air on the proposals to
curb PNs where he announced that funds investing through
PNs were most welcome to register as FIIs, whose registration
process would be made faster and more streamlined. The
markets welcomed the clarifications with an 879-point gain
on october 23rd

10.  Issue in this case, whether SEBI could ask FII to furnish undertaking that they
had not dealt in respect of ODI with Indian residents, non-resident Indians,
persons of Indian origin or overseas corporate bodies in absence of a bar on
such deals.
 Under the law there is no bar on the FII or their sub-account to deal with OCBs.
 The court said that it is not the case that the Board cannot call upon the FII to
report about their activities.
 The court is only disapproving the action of the Board in so far as it requires FII
to furnish the undertaking as prescribed for the first time in the revised
reporting format in absence of a bar prohibiting them from dealing in ODIs.

11.  SEBI wanted to investigate whether the conduct of UBS and
other players was in violation of SEBI (prohibition of
fraudulent and unfair trade practices relating to securities
market) regulations, 2003.
 SEBI called for information from UBS relating to its major ODI
clients.
 There is no requirement under regulation 15A in terms of KYC
requirement to give the names of top 5 investors of the
clients of UBS.

12.  Under regulation 20 every FPI shall submit information,
documents as and when required by the Board.
 The court said that a plain reading of regulation 20 makes it
clear that it is not obligatory on the part of the FII to provide
information pertaining to top five investors of the clients of
UBS.