Govt cracks down on P-Note misuse

600 cases of violation identified, information sought from 200 issuers

Fears of P-Notes (participatory notes) being misused have surfaced again despite the tightening of the framework in which they operate.

According to government sources, around 600 P-Note subscribers could be in violation of the framework issued by the Securities and Exchange Board of India (Sebi) in May last year.

Last year, Sebi had tightened the ‘know your client’ and anti-money laundering (AML) rules for P-Notes, bringing them on a par with those for onshore investors.

Besides, it had issued curbs on transferring P-Notes from one foreign investor to another.

Sources said the government and Sebi had asked P-Note issuers to probe non-compliance by 200 entities. Some of the instances of violation have been reported by overseas securities regulators, which are in a pact to share information of this kind.

The nature of non-compliance includes lack of details on the end-beneficiaries and not obeying the AML rules.

P-Notes, or offshore derivatives instruments (ODIs), allow foreign investors to take exposure to Indian stocks without registering with Sebi. These instruments are issued by foreign portfolio investors (FPIs) registered with the regulator. 

Cracking down on non-compliance is tricky because the subscribers or end-beneficiaries don’t come under the watch of the domestic regulatory authorities. Sources said the regulators could come down on issuers if they are able to establish widespread non-compliance.

The misuse of the P-Note route has become a talking point after the Supreme Court-appointed Special Investigation Team on black money had highlighted that the route could be used for tax dodging and the round-tripping of funds. 

The issue of further tightening the P-Note norms was discussed in the latest Sebi board meeting, which took place on February 11. However, Sebi had felt that it might not be warranted, given the stricter regulations it had introduced last year.

Sebi has assured the finance ministry that it has put enough checks and balances on issuing P-Notes. The increased compliance has led to a significant decline in the share of P-Notes in the FPIs’ investment pie. 

Corporate lawyer H P Ranina says no regulations can be free from loopholes. “The new framework is good but implementation could be a challenge. There could be some end-beneficiaries who could be resident Indians operating as benamis.”

Legal experts say the new framework is comprehensive but its effectiveness needs to be tested.

“The revised norms required issuers of ODIs to put in place additional systems, processes and controls and also evaluate and report on their functioning annually to Sebi,” said Sai Venkateshwaran, partner and head, accounting advisory services KPMG. “While the deadline for the first annual reporting has not passed, issuers were required to file the monthly and other periodic filings from July 2016 onwards. 

Considering that it is still in the first few months of implementation, it may be premature to comment on the effectiveness or the shortcomings of the new norms,” he added.

The tighter P-Note regulations have not only reduced the significance of this route but also seen some issuers exit the business. FPIs, including HSBC, UBS and Macquarie, are said to have shut down P-Note operations in India.