A little less than 10 years earlier, a Reserve Bank of India committee on fuller capital account convertibility, headed by S S Tarapore, passed a death sentence on Participatory Notes (P-notes). Stop new issues and wind down everything in a year, it had said.
In October 2007, the Securities and Exchange Board of India (Sebi) had restricted foreign institutional investors (FIIs) and their sub-accounts from issuing or renewing P-notes with derivatives as the underlying assets with immediate effect. They were required to wind up their current positions in 18 months. P-notes could also not exceed 40 per cent of an FII’s assets under management.
It was around this time that the first of many premature obituaries of P-notes were written. The regulations were called ‘death knell’ for the offshore instruments and many other grave expressions were tossed around.
It was not the last time we saw the regulator eating crow. There were provisions in the 2014 Foreign Portfolio Investor (FPI) regulations that again were expected to kill P-notes, at least the bad ones which act as conduits of undisclosed (‘black’) money. The regulations required that P-notes be issued only to regulated entities in Financial Action Task Force-compliant nations. And, that the issuing FPI needed to give a declaration that these were compliant with the Know Your Customer norms.
Yet, in the clarificatory Frequently Asked Questions list it later issued, Sebi said P-notes issued before the commencement of the Regulations as on January 7, 2014, as well as the existing subscribers as on that date, were grandfathered (the legal term that a rule does not apply to something that had happened before it was made).
Another obituary went up in smoke. In April 2012, the notional value of P-notes on equity was Rs 81,647 crore and that on derivatives was Rs 43,227 crore. Four years later, in April 2016, the corresponding numbers were Rs 131,627 crore and Rs 50,852 crore. Between these two dates, the numbers hit a high in May 2015 at Rs 1.81 lakh crore and Rs 71,663 crore, respectively. While the decline since then could be attributed to adverse comments by the Special Investigation Team (SIT) probing black money, in July 2015, the absolute numbers are not small by any standards.
Sebi spent a lot of time in the days after the SIT report in explaining how it already knew everything about P-notes. Media interviews of Sebi and the finance ministry from the time painted a picture that all was well with the regime and the SIT was over-reacting.
Ten months later, new rules have been notified. If all was well then, why these changes now? Nevertheless, the ‘death knell for P-notes’ theme has been sounded again. According to the fineprint that came after all the braggadocio settled, identification and verification of beneficial owner is required only if subscribers hold in excess of 25 per cent in the case of a company and 15 per cent in partnerships, etc.
Does that mean a person holding 24.99 per cent in the subscriber company can round-trip happily ever after? The P-notes are dead. Long live P-notes.
In October 2007, the Securities and Exchange Board of India (Sebi) had restricted foreign institutional investors (FIIs) and their sub-accounts from issuing or renewing P-notes with derivatives as the underlying assets with immediate effect. They were required to wind up their current positions in 18 months. P-notes could also not exceed 40 per cent of an FII’s assets under management.
It was around this time that the first of many premature obituaries of P-notes were written. The regulations were called ‘death knell’ for the offshore instruments and many other grave expressions were tossed around.
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Only a few months later, the scene changed dramatically. From being a flood, inflows from abroad dried to a trickle in the wake of the subprime mortgages-induced global crisis. Sebi, then under a new chairman, held on to its regime bravely for a few months. From Rs 1.37 lakh crore in September 2007, the value of P-notes with derivatives as underlying assets shrunk to Rs 4,841 crore in September 2008. The resolve broke after the collapse of Lehman Brothers that month. In October 2008, Sebi lifted its restrictions; the 18-month deadline and 40 per cent cap were gone. The “changed context” was given as reason for the U-turn.
It was not the last time we saw the regulator eating crow. There were provisions in the 2014 Foreign Portfolio Investor (FPI) regulations that again were expected to kill P-notes, at least the bad ones which act as conduits of undisclosed (‘black’) money. The regulations required that P-notes be issued only to regulated entities in Financial Action Task Force-compliant nations. And, that the issuing FPI needed to give a declaration that these were compliant with the Know Your Customer norms.
Yet, in the clarificatory Frequently Asked Questions list it later issued, Sebi said P-notes issued before the commencement of the Regulations as on January 7, 2014, as well as the existing subscribers as on that date, were grandfathered (the legal term that a rule does not apply to something that had happened before it was made).
Another obituary went up in smoke. In April 2012, the notional value of P-notes on equity was Rs 81,647 crore and that on derivatives was Rs 43,227 crore. Four years later, in April 2016, the corresponding numbers were Rs 131,627 crore and Rs 50,852 crore. Between these two dates, the numbers hit a high in May 2015 at Rs 1.81 lakh crore and Rs 71,663 crore, respectively. While the decline since then could be attributed to adverse comments by the Special Investigation Team (SIT) probing black money, in July 2015, the absolute numbers are not small by any standards.
Sebi spent a lot of time in the days after the SIT report in explaining how it already knew everything about P-notes. Media interviews of Sebi and the finance ministry from the time painted a picture that all was well with the regime and the SIT was over-reacting.
Ten months later, new rules have been notified. If all was well then, why these changes now? Nevertheless, the ‘death knell for P-notes’ theme has been sounded again. According to the fineprint that came after all the braggadocio settled, identification and verification of beneficial owner is required only if subscribers hold in excess of 25 per cent in the case of a company and 15 per cent in partnerships, etc.
Does that mean a person holding 24.99 per cent in the subscriber company can round-trip happily ever after? The P-notes are dead. Long live P-notes.