P-Notes: Foreign investors fine with key Sebi proposals

The total outstanding investment through ODIs stood at over Rs 2.2 lakh crore at the end of March 2016.

Published: 15th May 2016 06:05 PM  |   Last Updated: 15th May 2016 06:05 PM   |  A+A-


NEW DELHI: As Sebi readies to tighten its rules for controversy-ridden P-Notes, major foreign investors including JPMorgan, HSBC, UBS and Goldman Sachs have supported the proposed provisions for immediate reporting of any breach to the regulator and filing of suspicious transaction reports.

However, these investors have opined that introduction of any further control measures is unlikely to be "resource effective" as the regulatory requirements in India are already more stringent than other jurisdictions globally for Offshore Derivative Instruments (ODIs) commonly known as Participatory Notes or P-Notes.

They have also sought to allay concerns emanating from a large chunk of end-beneficial owners of P-Notes being located in Cayman Islands, which accounts for over 41 per cent of all such entities.

In a representation before the capital markets regulator, these investors said the fund managers invest money on behalf of many investors and that needs an entity to pool such investments.

As many funds have hundreds -- at times thousands -- investors from multiple countries, it is not possible for a fund manager to open separate securities and banking accounts for each investor across different markets and Cayman Islands happens to be "one of the eligible jurisdictions with regard to investments as FPIs as well as subscription of ODIs".

They also said the establishment of funds in Cayman Islands is independent of their decision to invest in India as these funds invest globally and India is "often just one part of their portfolio".

As part of an analysis conducted by Sebi, which would consider a tighter set of norms for P-Notes next week, Cayman Islands is followed by Mauritius (11.09 per cent) as the second-biggest location for end-beneficial owners of ODIs. Other major locations include the UK and the US with over 10 per cent share each.

Typically, P-Notes are instruments issued by registered foreign institutional investors to overseas investors who wish to invest in the domestic stock markets without registering themselves directly in India, but still need to go through a proper due diligence process.

P-Notes now make up for about 10 per cent of the total FII inflows as against over 50 per cent at the peak of stock market bull run in 2007. Rules have been tightened several times in recent years to check any misuse of this route, but P-Notes have still continued to court controversies.

The total outstanding investment through ODIs stood at over Rs 2.2 lakh crore at the end of March 2016.

As of March 31, 2016, as many as 37 foreign portfolio investors (FPIs) reported outstanding ODIs, out of which the top 10 accounted for 73 per cent share. The biggest FPIs in this regard included arms of Morgan Stanley, Copthall Mauritius Investments, Goldman Sachs, Credit Suisse, HSBC, Merrill Lynch, Citigroup, Swiss Financial Corp and JPMorgan.

Out of a total of 2,448 entities that are subscribing to ODIs, over 60 per cent are interestingly mutual funds.

The foreign investors that made their representations before Sebi also included Barclays, Bank of America Merrill Lynch, BNP Paribas, CLSA, Credit Suisse, Deutsche Bank, Macquarie, Morgan Stanley, Nomura, Societe Generale and Standard Chartered.

The foreign investors said they were "supportive of Sebi requiring breaches in which ODIs are transferred to ineligible counterparties to be reported to Sebi as soon as practicable after identification".

Besides, they also extended their support for ODI issuers being explicitly required to report to the Financial Intelligence Unit (FIU-India) the cases of suspected market abuse through use of ODIs in form of STRs.

Acting upon recommendations of the special investigation team (SIT) on black money, Sebi plans to tighten due diligence requirements for issuance and transfer of controversy-ridden P-Notes and put the onus on investors to ensure compliance with anti-money laundering law.

While Sebi (Securities and Exchange Board of India) has been of the view that the regulations have already been strengthened to check any misuse of this route for money-laundering like activities, it has decided to put in place additional safeguards as suggested by the SIT.

The regulator plans to put in place six specific changes to the KYC (Know Your Client) norms and transferability of ODIs in this regard.

The foreign investors, however, said that increasing the KYC-related requirements as such would not effectively curtail any market conduct violations.

The proposed changes have been finalised after discussing with stakeholders concerned, including some major issuers of P-Notes, and they have broadly agreed to the suggested measures in the interest of the markets, a senior official said.

These include mandating the issuers of P-Notes to file Suspicious Transaction Reports (STRs), if any, with the Indian Financial Intelligence Unit (FIU) in relation to the ODIs issued by them.

On KYC guidelines, while current regulations also mandate that ODIs can be issued only after compliance to the KYC requirements, the issuer entities have been adopting either the Indian AML (Anti-Money Laundering) norms, norms in the jurisdiction of the issuer or the rules in the jurisdiction of the end beneficial owner or the ODI subscriber.

As per the proposal, Indian AML norms would need to be followed by issuer entities for carrying out customer due diligence of the ODI subscribers.

Officials said the regulations have been very robust to check any misuse of P-Notes and the proposed changes might not affect the flow of funds in a big way as they are mostly procedural in nature and do not drastically change the regulatory framework.

The Supreme Court-appointed SIT on black money last year had suggested that Sebi should further strengthen its norms to keep a tab on beneficial ownership of P-Notes as these are widely used by foreign investors and could be prone to misuse.

The slew of measures that have now been proposed by Sebi in this regard would require the ODI issuers to identify and verify the persons with exposure in excess of a pre-defined threshold in the subscriber entities -- which could be 25 per cent in the case of a company and 15 per cent in the case of partnership firms, trusts or unincorporated bodies.

The issuer would also need to do reconfirmation of the ODI positions on a semi-annual basis while such reconfirmation reports, along with any breaches and the remedial actions, would need to be reported to Sebi.


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