Fresh issuance of overseas derivative instruments or participatory notes (P-notes) has come to a near-stop over recent months.
While the fear of retrospective tax under the General Anti-Avoidance Rules (GAAR) was a big reason, market participants believe another big reason is tighter regulation and increased disclosures sought from foreign institutional investors issuing these.
Most said the share of P-notes in foreign inflows would come down further. Foreign individuals and entities interested in investing in India would have the Qualified Foreign Investor (QFI) window to invest in listed debt, equity and unlisted entities. The QFI window is in addition to the existing FII and FDI route.
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It is widely believed that PNs were issued to individuals and entities like family offices and companies not entitled to invest in Indian equities directly. Rajesh Churuvu, chief investment officer, India, Royal Bank of Scotland, said: “The investments that were coming through the P-Notes route will now be routed through the QFI window.”
Last year, the government opened this window for foreign non-institutional investors to invest in Indian equities (not derivatives). This route has since been broadened to include investments in listed debt and unlisted companies.
“Earlier, if an investor wanted to invest in these three categories, they needed to set up different structures and get different clearances. Now, they can do all this through one registration,” said Praveen Chakravarty, CEO, Investment Banking and Equities – Anand Rathi Financial Services.
Regulators across markets are cracking down on opaque derivative structures by seeking more disclosures. India opened the QFI window as it wants those entities routing investment through P-notes to come directly. From October, P-Note issuers will have to disclose details on issuance and transactions monthly, along with a summary report.
P-Notes were banned in 2007, as their share of total FII equity investments had crossed 50 per cent. They were allowed again in 2008. The fact that they are losing favour is also apparent from the fall in total value of PNs on equity and debt (including PNs on derivatives) and their share in percentage terms. Thirty market participants have already registered with Sebi as Qualified Depository Participants in anticipation of such flows. RBS’ Churuvu believes further non-FII foreign investments are expected to flow through QFIs rather than the erstwhile PNs, as the new QFI route is a simple and transparent way to invest in India for foreign entities.
Market participants believe this route has the potential to bring large sums to India. However, inflows have not yet happened, as investors are waiting for clarity on how income tax would be levied.
Sidharth Shah, partner, funds practice, at Nishith Desai Associates, said: “QFIs will have to file tax returns in India if they are not coming through countries/regions with which India has signed double tax avoidance treaty. It is expected that CBDT will clarify on tax treatment and QFIs are likely to be covered under Sec 115AD of the I-T Act.”
