As Sebi cracks down, costs go up, popular P-Notes lose sheen

Once a popular investment tool with foreign investors, participatory notes (P-Notes) apppear to be losing much of their sheen following the continuous tightening of rules by the regulator Securities and Exchange Board of India (Sebi). The product has become less attractive, market players say, because the new rules have resulted in costs going up.

Investments in Indian capital markets via P-notes declined to R1.79 lakh crore in November 2016, the lowest in three years. Data from SEBI revealed that in November 2007, the share of P-notes accounted about 45% of the total foreign portfolio investments — across debt, equity and derivatives. By end 2016 this amount had fallen to single digits at 7.5%. While the total value of FPI investments stood at R24.09 lakh crore, the value of P Notes was R1.79 lakh crore.

Recently, media reports noted that HSBC, which was among the top five issuers of P notes, had decided to close down the business in India. According to sources, the renegotiated Double Taxation Avoidance Agreement (DTAA) with Mauritius has also impacted the business of HSBC, which is registered in Mauritius.

Earlier this year, SEBI further tightened rules on issue of P-notes to bring in more transparency. The capital markets watchdog notified that the know your customer (KYC) or anti- money laundering rules ( AML) will be applicable to P-note holders. In July, it put curbs on the transferability of P- notes between two foreign investors.

After a board meeting in JUly, U K Sinha, chairman, SEBI had observed that both the government and SEBI viewed participatory notes to be legitimate instruments required for normal financial transactions. “They are prevalent in all the larger markets. I would strongly argue that there can be a genuine situation where PNs have to be issued,” Sinha had said at the time.

“The current regulatory regime allows foreign investors the same benefits in terms of exposure limits and margins as given to domestic entities,” Sinha added.

Changes were made to P-notes regulations following recommendations made by a Special Investigation Team (SIT), set up by Supreme Court to address the issue of untaxed wealth. Sandeep Parekh, founder of Finsec Law Advisors believes these are knee-jerk reactions. “I believe the new norms for ensuring transparency are positive steps,” Parekh said.

Securities and Exchange Board of India ( SEBI )