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It is very rare of investors and the government to think on the same lines. But the recent report by Supreme Court appointed Special Investigation Team (SIT) on participatory notes (P-notes) has united the two. Both investors as well as the government are worried over the report which they fear will lead to foreign money leaving Indian shores.
Finance minister, Arun Jaitley, who was heavily criticised on the issue of application of MAT on FIIs, seems to be a quick learner. His ministry has issued statements assuring investors that the government will not take steps that will affect investments, following the SIT report.
Both government and the investors are worried as investments through the P-note route is around Rs 2.45 lakh crore or 10.25 per cent of the total foreign portfolio investment (FPI) in the country of Rs 23.86 crore.
The government’s concern is a valid one, especially when P-notes have followed the rules of the game, changing the rules will result in a similar kind of backlash that the previous government received while introducing retrospective tax.
While the government tries to resolve this situation without impacting the markets adversely, let’s look at what is a P-note and why the SIT wants them to be tracked.
1) P-notes or PNs are instruments issued by registered foreign institutional investors (FII) to overseas investors, who wish to invest in the Indian stock market without registering themselves with the market regulator, the Securities and Exchange Board of India - SEBI.
P-notes are popular as it allows the idenity of the investor to be kept anonymous. FIIs are required to register with SEBI, but P-notes who trade through them are not.
2) No wonder P-notes have been controversial instruments from the start and every time the government wants to regulate them, market start falling preventing the government to take the harsh step. The government fears that P-notes are being used as instruments for money laundering. Even listed company promoters are believed to re-route their investments in their own companies through the P-note route. This allows them to flout the stringent insider trading norms that regulate such proprietary investments.
3) P-notes however, have other inherent advantages. They are easy to operate rather than the cumbersome rules that India has for its foreign investors. P-notes are like contract notes transferrable by endorsement and delivery. This nature of P-notes has attracted the SIT’s attention and rightly so.
4) P-notes are freely traded overseas, and is done without any jurisdiction or control of SEBI over it. This nature of P-note is like that of an informal ADR (American Depository Receipt) where the stocks are held by brokerages for their foreign investors.
Since P-notes are opaque and the identity of the owner is known only to the FII, trading them freely makes it very difficult to find the original owner of these P-notes.
5) However, SIT’s decision to seek a clarification is a welcome move. For the markets, knowing the identity of the participant is healthy, but the initial reaction to the news seems to be a knee-jerk reaction. Further, SIT has asked for stricter compliance norms of P-notes and has said nothing on banning them.
Share of P-notes has already come down from 50 per cent in 2007 to around 11.5 per cent presently. However, memories of the sharp 1744 point fall on October 17, 2007 and subsequent volatilities on following days when SEBI first proposed curbs on P-notes is enough to spread fear in the mind of investors and government alike.
