What is Participatory Notes

Participatory Notes as known as P-Notes or PN are instruments issued by registered foreign institutional investors to overseas investors, who wish to invest in the Indian stock markets without registering themselves with the market regulator, the Securities and Exchange Board of India.

In simple words, P-Notes are Financial instruments used by investors or hedge funds that are not registered with the Securities and Exchange Board of India to invest in Indian securities. Indian-based brokerages buy India-based securities and then issue participatory notes to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investors. This is because the Indian capital market is limited to FII’s.

How P-Notes works?

The investors, who buy PNs, deposit their funds in the US or European operations of the FII, which also operates in India. The FII uses its proprietary account to buys stocks in India. A government report has said that the FII or the broker acts like an exchange since it executes the trade and uses its internal accounts to settle this. Other such instruments include equity-linked notes, capped return note, participatory return notes and investment notes.

Major Disadvantages of Participatory Notes

1. While one reason for using PNs is to keep the investor's name anonymous, some investors have used the instrument to save on transaction costs, record keeping overheads and regulatory compliance overseas

2. It is difficult to establish the beneficial ownership or the identity of the ultimate investor, that is possible for registered FIIs. It fears that FIIs, which have to comply with the know-your customer norms, know the identity of the investor to whom the note was issued. But it is possible for the investor to sell the PN to another player resulting in multi-layering. Tax officials fear that PNs are becoming a favorite with a host of Indian money launderers who use the instrument to first take out funds out of the country, through the hawala route, and then get it back using PNs.

Who can invest in Participatory Notes?

a) Any entity incorporated in a jurisdiction that requires filing of constitutional and/or other documents with a registrar of companies or comparable regulatory agency or body under the applicable companies legislation in that jurisdiction;

b) Any entity that is regulated, authorised or supervised by a central bank, such as the Bank of England, the Federal Reserve, the Hong Kong Monetary Authority, the Monetary Authority of Singapore or any other similar body provided that the entity must not only be authorised but also be regulated by the aforesaid regulatory bodies;

c) Any entity that is regulated, authorised or supervised by a securities or futures commission, such as the Financial Services Authority (UK), the Securities and Exchange Commission, the Commodities Futures Trading Commission, the Securities and Futures Commission (Hong Kong or Taiwan), Australian Securities and Investments Commission (Australia) or other securities or futures authority or commission in any country , state or territory;

d) Any entity that is a member of securities or futures exchanges such as the New York Stock Exchange (Sub-account), London Stock Exchange (UK), Tokyo Stock Exchange (Japan), NASD (Sub-account) or other similar self-regulatory securities or futures authority or commission within any country, state or territory provided that the aforesaid organizations which are in the nature of self regulatory organizations are ultimately accountable to the respective securities / financial market regulators.

e) Any individual or entity (such as fund, trust, collective investment scheme, Investment Company or limited partnership) whose investment advisory function is managed by an entity satisfying the criteria of (a), (b), (c) or (d) above.

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