Sebi may soften P-notes blow

Market regulator to meet FIIs, hedge funds.

In a move that could be of some relief to foreign institutional investors (FIIs), the Securities and Exchange Board of India(Sebi) is considering a proposal to allow proprietary sub-accounts to issue participatory notes (P-notes).

Sebi Chairman M Damodaran is expected to discuss these and other proposals when he meets representatives of FIIs and hedge funds through a video conference on Monday. Sebi is expected to finalise the guidelines at its board meeting on October 25.

Last week, the market regulator had proposed, among other things, a general ban on sub-accounts of FIIs issuing P-notes, which are offshore derivative instruments used by hedge funds and investors that are not registered in India.

Many FIIs, however, have proprietary sub-account that are formed to invest their own money. These sub-accounts issue P-notes purely as an investment opportunity to earn a good return at minimum cost.

Proprietary sub-accounts are different from other sub-accounts that are largely corporate structures or special purpose vehicles formed in tax havens by unregistered investors, with FIIs investing the money on their behalf.

FIIs are of the view that they are already registered so there should not be a ban on P-notes issued by their own sub-accounts.

Sebi had proposed various controls on P-notes last week as a means of controlling massive capital inflows.

The other proposal that is under Sebi's active consideration is to allow FIIs to hedge equity investments through P-notes that they issue.

While P- notes on equity instruments are allowed, Sebi had proposed to ban FIIs from issuing P-notes in derivatives, which makes hedging difficult.

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The absence of a hedging facility for P-notes investments was one of the bigger concerns of foreign investors and played a major role in last week's steep stock market fall.

Meanwhile, sources said the government was also considering a turnover tax on issuance and trading volumes of P-Notes in the long term.

While FIIs pay capital gains tax on their transactions, there is no tax on P-notes since they do not originate in India. However, to discourage the issuance of P-notes, a turnover tax is being considered.

To simplify registration norms for FIIs "" the lack of which was one of the key reasons for the massive growth of P-notes in recent months "" Sebi proposes to approach the Reserve Bank of India to put clearance under the Foreign Exchange Management Act on the fast track.

According to Sebi, P-notes now account for more than half of the FII inflows from 34 per cent two years ago.

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