HSBC, UBS stop issuing P-Notes as Sebi, govt step up clampdown

A number of foreign investors, including HSBC and UBS, have stopped issuing controversy-ridden Participatory Notes (P-Notes) as regulatory and enforcement agencies step up their clampdown on misuse of this once-popular instrument among foreigners to invest in Indian markets.

The Securities and Exchange Board of India (Sebi) has shared with the government for further action a list of foreign fund houses that are found to have issued the offshore derivative instruments (ODIs), popularly known as P-Notes, to Indian nationals, while a probe is on in several other suspected cases of Non-resident Indians (NRIs) and Persons of Indian origins (PIOs).

These instruments are not allowed to be issued to Indians, NRIs or POIs.

Besides, another list has been shared of the investors having parked large amounts of money, each worth over $100 million, through these instruments.

Sebi has stepped up its scrutiny of investors issuing P-Notes, as also those parking their money in Indian markets through this route, amid a stepped-up clampdown on their misuse for round-tripping illicit funds.

These instruments used to be very popular at one point of time among foreign investors who did not want to enter the market directly and used to invest through this route provided by registered foreign portfolio investors (FPIs).

Consistent tightening of norms, including as per the suggestions of the Supreme Court-appointed Special Investigation Team (SIT) on Black Money, has led to a sharp decline in its share — from 56 per cent about ten years ago to less than seven per cent of overall foreign portfolio investments in Indian markets currently.

There was a drastic decline in the outstanding values of the ODIs from the month of October to December 2016.

Among others, JPMorgan saw the value of ODIs decline by 77 per cent, while the fall was 62 per cent for Societe Generale, 58 per cent for Bank of America, 51 per cent for Citicorp and 46 per cent for Goldman Sachs.

"The ODI issuer such as HSBC Bank Mauritius Ltd has stopped issuing further ODIs and has reported 'nil' outstanding values of ODIs as of December 31, 2016," a top official said, while adding that Swiss bank UBS is also said to have stopped issuing ODIs from January.

Sebi has seen the compliance cost for ODI issuing FPIs also increase due to consistent tightening of norms by the regulator, while simultaneous liberalisation of FPI norms have made ODI route "less attractive vis-a-vis taking direct registration".

Mauritius and Singapore based FPIs issue ODIs to overseas investors which comprised 87 per cent of FPI flows through this route, also because of favourable tax treaties.

Now, with the tax treaties with these two countries having been revised by India, FPIs are not able to allocate the tax incurred to the respective ODI subscriber in a manner that no ODI subscriber is impacted by tax liability pertaining to another subscriber.

"Thus, FPIs have been reducing their exposure in ODIs," the official said.

Sebi had also collected KYC details of as many as 52 entities having outstanding value of ODIs of $100 million or more. These details have been shared with the government also for further action on their end.

The markets regulator has also found five foreign funds to have issued these controversy-ridden offshore investment instruments to Indian nationals.

Besides, four registered FPIs have issued P-Notes to foreign nationals with "Indian sounding names" and Sebi has asked them to confirm if those individuals are NRIs or PIOs.

The regulator would take "suitable action" on receipt of details from the fund houses.

Following tightening of ODI norms by Sebi to check any misuse for round-tripping of funds, these instruments cannot be issued to Indians, NRIs or PIOs.

Among others, Indian nationals were issued ODIs by the FPIs that are arms of some large global banks from the US, Switzerland and Australia. They have been asked by Sebi not to issue any fresh ODIs to such subscribers and square off the existing position on maturity or by December 31, 2020.

In a communication to the government on the progress on detection of beneficial ownership (BO) information with regard to P-Notes, Sebi further said there are 10 ODI issuing FPIs which are yet to provide the beneficial owner details of their clients in the prescribed format.

"These FPIs have expressed their inability to provide the BO information," Sebi said, adding that they have been asked to provide the details by March 31, 2017. Till that time, they cannot issue any fresh ODI to existing clients, though they can issue such instruments to new clients after receipt of BO information as per Sebi norms.

As part of its efforts to tighten the norms for P-Notes, Sebi last year introduced new KYC norms for such instruments and asked the FPIs to provide details in a new format for information about the end beneficial owner.

First such BO information, along with the complete ODI, was received by Sebi in November 2016, after which it carried out an analysis of the submissions made by 38 ODI-issuing FPIs.

Consequently, Sebi has shared the progress report with the government along with its observations from the analysis.

In case of ODI subscribers where the percentage holding of beneficial owner was not provided, Sebi has asked those FPIs to provide the same at the earliest and would take "suitable action" consequently.