P-Notes & Sebi

R.I.P.: P-Notes?

Market regulator, Securities and Exchange Board of India (SEBI) has upped its ante on Participatory Notes (P-notes). In its two successive board meets of April and June, SEBI has announced measures aiming to clamp down foreign investments through P-notes.

Off shore derivatives instruments (ODIs) or P-notes, as they are generally referred to, are issued by SEBI-registered foreign portfolio investor (FPI) and are subscribed by foreign investors that either want to hide their identity or doesn’t like the unnecessary compliance cost.

In the Indian context, over the years, P-notes are seen as opaque structures hiding the identity of the ultimate investor. Allegedly P-notes are often misused to avoid taxes, increase speculation, round tripping and money laundering. Indian regulators dislike P-notes and have taken many measures to tame it.

In April, SEBI prevented resident and non-resident Indians (NRIs) to use P-notes for investment into Indian markets. SEBI also restricted entities that are beneficially owned by NRIs from subscribing to ODIs.

Further, in June, the regulator proposed to levy a fee of $1000 on each P-note issued by FPI once every three years retrospectively from April 1, 2017. The regulator also prohibited issuance of P-notes by FPI that has no underlying in the cash market.

Simultaneously, the regulator plans to liberalize its registration process. More recently on June 28, SEBI came out with a consultation paper with an aim to ease access for FPIs in India. All the recent moves are in line with the regulator’s aim to make Indian market transparent and make P-notes less attractive as aninvestment route.

Dying specie

P-notes as an investment route for foreign investors will eventually become irrelevant. This is because the compliance and regulatory cost will slowly kill them.

Foreign investments through P-notes are already on the downward trajectory. In 2007, 50% of all foreign investments into India were through P-notes. In 2017, P-notes route comprised only 6% of all foreign investments. In absolute terms, in 2007 the outstanding value of these instruments stood at around Rs4.1 trillion. This has fallen to Rs1.7 trillion in April 2017.

Policy measures

Globally, there has been increased sensitivity about opaque tools of investments like P-notes. Even Indian government, with its mission to finish black money, has been wary about p-notes.

Rules on p-notes have been tightened several times in recent years. Tightening of norms on P-notes by SEBI intensified after suggestions from Supreme Court-appointed Special Investigation Team (SIT) on black money in July 2015.

The SIT was set up to address the issue of black money and untaxed wealth. SIT flagged P-Notes, issued by foreign institutional investors as a possible conduit for illegal funds in the capital market. The SIT report suggested increased regulation of fund flows through this route. SEBI has been on the edge to contain P-notes.

In May last year, SEBI made Indian know your client (KYC) and anti money laundering (AML) norms applicable to all P-note issuers. SEBI mandated P-note issuer to report any suspicious transactions to Indian authorities. Transfer of P-note was also made difficult. Further, the P-note issuer also needed to report the trail of P-note exchanges over the month to the regulator. The P-note issuer had to also identify the subscriber.

Current clampdown

While SEBI doesn’t desire a complete clampdown on P-notes, the regulator through its various policy measures has already succeeded in reducing the attractiveness of P-Notes. The measures announced in the past few weeks will also make indulgence in P-notes cumbersome.

Prevent resident/ non resident Indians (NRIs) to use P-notes: SEBI prevented resident and non resident Indians (NRIs) to use P-notes for investment into Indian markets. SEBI also restricted entities that are beneficially owned by NRIs from subscribing to P-notes.

Analysis: There have been cases of round tripping of black money of resident or NRIs via P-notes. In the past also, SEBI has expressed its dislike for NRIs using the P-Note route to invest in India. Many big FPIs that issue P-notes have already restricted NRIs to subscribe to P-notes. Now, issuers will also have to prevent entities that are beneficially owned by NRIs from subscribing to ODIs.

With NRI related entities within the ambit, the practice of round tripping of black money will be prevented in the truest sense.

$1000 fee per P-note for 3 years: SEBI has levied a fee of $1000 on each P-note issued by FPI for a period of three years retrospectively from April 1, 2017. Simply put, if a subscriber uses three FPIs for subscribing to p-notes, he will have to pay $3000 as regulatory fees to SEBI.

Analysis: Quite a few P-note subscribers invest through multiple issuers. Now, the regulatory fee will discourage the ODI subscriber from taking ODI route and encourage them to directly take registration as an FPI. Also, SEBI incurs a significant capital (mostly information technology and systems) and man power expenditure in monitoring P-notes. The regulatory fees will make P-notes expensive on one side and also subsidise SEBI’s expenses.

Prohibit naked derivates position on which P-notes are issued: SEBI has prohibited P-notes from being issued against derivatives on which there is no cash market underlying. Typically, issuer takes a position in the Indian derivatives market and issues P-notes on that position. But, that position may not have any cash market co-relation. Now, SEBI mandates P-notes on derivatives only if there is cash market underlying.

Analysis: FPI issuer may have no cash position, but an unlimited derivative position on which it can issue P-notes. This is highly speculative. SEBI now prohibits such naked positions in the market. FPI's can continue to issue P-Notes against cash positions. All existing naked derivatives positions on which P- notes were issued will have to be unwound. This can be done on the immediate expiry day or before Dec 2020.

This move by SEBI is disruptive. As of April 2017, P-notes issued against derivatives had a notional value of Rs 40,165 Cr which is 24% of the total notional value of all outstanding P-notes. So, all the naked positions will be unwound as early as possible.


Although SEBI is trying to discourage usage of P-notes; it does not want to repel genuine foreign investors. With an aim to encouraging FPIs to invest directly, SEBI has come out with a consultation paper on easing of entry norms for FPIs. SEBI proposes to expand eligible jurisdictions for registration of FPIs. The regulator also proposes to rationalizing eligibility criteria for existing FPIs. SEBI also proposes to simplify regulatory requirements for FPIs. With some relaxations in the pipeline, many foreign investors will shun the P-notes route and register themselves as FPI with SEBI.



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