CRITICAL ANALYSIS OF THE DEBATE PERTAINING

TO THE USE OF PARTICIPATORY NOTES

Legal Research Paper Submitted to Guru Gobind Singh Indraprastha
University in partial fulfilment of requirements for the degree of Bachelor
of Law

Submitted By
AKSHAY
Vth Year Student
Section: B
Enrollment Number: 18010303811

Amity Law School Delhi

F-1 Block, Amity University Campus, Sector 125, Noida, Uttar Pradesh
-201303

DECLARATION

This is to certify that the research paper titled Critical analysis of the debate pertaining to
the use of Participatory Notes which is submitted by me in partial fulfillment of the
requirement for the award of degree B.A.LLB(Hons.) in law to Amity Law School Delhi,
Guru Gobind Indraprastha University, Delhi comprises only my original work and due
acknowledgement has been made in the text to all other material used.

Date:

Signature of Student

TABLE OF CONTENTS
S.N
O

TOPIC

PAGE NO.

1.

Acknowledgment

1.

2.

Abstract

2.

3.

Introduction

3.

4.

Working of Participatory Notes

4.

6.

Concerns which sparked the debate over Participatory Note

5.

7.

Use of Participatory Note Route

7.

8.

Regulatory Timeline

9.

Requirement of KYC Compliance

Participatory Notes Crisis of 2007
Position with respect to Participatory Notes prior to
SEBI 2011 Circular
SEBI Circular dated January 07, 2011
SEBI Circular dated June 07, 2012
SEBI (Foreign Investment Portfolio Investors)
Regulation 2014
SEBI Circular dated November 24, 2014
9.
10.
11.

Recommendations of the SIT, 2015

Suggestions
Conclusion
Bibliography

14.
15.
16.

ACKNOWLEDGEMENT
The Research Paper is an outcome of my sincere and dedicated efforts towards analyzing the
issues behind the discussed topic. The points of view of several authors and thinkers have
been used to arrive at the same. The successful completion of my Research Paper can be
owed to numerous people. I would like to thank a few of them.
Firstly, I would like to express my sincere thanks to our Director, Prof. (Dr.) Dr. Isheeta
Ruthabhasini for introducing the concept of preparing a Research Paper, thereby allowing me
to table my perspectives about the discussed topic.
Further, I would like to thank Prof. (Dr.) Rajan Varghese , who not only encouraged me to
research but also went ahead to train us in the art of research. On a personal level, I thank the
Almighty Lord, my family and friends for supporting me throughout this journey and being
least complaining in terms of the time I gave to this Research Paper instead of them.

Akshay
18010303811
B.A., LL.B (H) (Final Year)

CRITICAL ANALYSIS OF THE DEBATE PERTAINING TO

THE USE OF PARTICIPATORY NOTES
Akshay1

Participatory Notes are basically offshore derivate instruments which are issued by foreign
portfolio investors against such securities held by them which are listed or proposed to be
listed on recognised stock exchange. Participatory Notes were nowhere defined before the
Foreign Portfolio Investors Regulation, 2014 came into operation after replacing the Foreign
Institutional Investors Regulation, 1995. Ease of trading, anonymity and tax avoidance are
some of the prime reasons why Participatory Route gained popularity among foreign
investors. How far is the tax avoidance justified is also a matter of debate, which will be
dealt with in the paper. The basic concern which sparked the debate over the use of
participatory note is that it is alleged that the Participatory Note Route can be used to divert
the unaccounted fund, i.e. Black Money into India. It is speculated that Participatory Notes
can be misused by Indian Money Launderers who may use them to first take funds out of the
country through Hawala and then get it back by using Participatory Notes. Recently, the SIT
set up by the Indian Supreme Court has given specific recommendations on Participatory
Notes in its report. Thus it is of utmost importance to critically dissect each and every aspect
pertaining to Participatory Notes in order to draw any conclusion.
This paper attempts to lay down the reasons for origin of Participatory Note Route, the
manner of working of such notes with special emphasis on the SEBI regulations aiming to
regulate the use of participatory Notes. The paper will also discuss the recent
recommendations given by the SIT set up by the Supreme Court.

I. Introduction
1 5TH yr. student, Amity Law School Delhi (GGSIPU), email id:- akshaypathak.123@gmail.com.
2

The Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act,
2015 recently received the assent of the president. The Act aims to target the black money
abroad and imposes high monetary and criminal prosecution for its violation. It is pertinent to
mention that there is a high possibility that the black money stacked abroad is being rechannelized and is being introduced in the economy through offshore derivative instruments
known by the name of Participatory Notes or P-Notes. It is believed that the unaccounted
money is sent abroad through hawala and then brought back unnoticed and untraced by way
of investment in the Indian stock market.
A Participatory Note (PN or P-Note) in the Indian context, in essence, is a derivative
instrument issued in foreign jurisdictions, by a SEBI registered Foreign Portfolio Investor
(FPI) or its sub-accounts or one of its associates, against underlying Indian securities. The
underlying Indian security instrument may be equity, debt, derivatives or may even be an
index. In January 2014 when the Indian securities market regulator, SEBI issued the new
Regulations for Foreign Portfolio Investors, participatory notes got formally defined under
the tag "Offshore Derivative Instrument" (ODIs) in Section 2(1)(j) of the said regulation. 2 As
per this definition, participatory notes or ODIs are issued overseas by a foreign portfolio
investor against securities held by it that are listed or proposed to be listed on any recognised
stock exchange in India, as its underlying. Participatory notes are instruments used for
making investments in the stock markets. However, they are not used within the country.
They are used outside India for making investments in shares listed in the Indian stock
market. That is why they are also called offshore derivative instruments.
RBI had already raised its concerns regarding the use of participatory notes and suggested
that the use of such notes must be done away with. Even though the use of P-Notes was
temporarily suspended yet the dependency of the stock market of the P-Notes leads to their
revival and increased use. The anonymity of the beneficial owner of the P-Notes has always
been the prime concern and SEBI has time and again come up with regulations with respect
to the same. The need of use of P-Notes, the possibility of doing away with their use is
something which is a debatable issue considering the fact that P-Notes are alleged to bring
unaccounted money into Indian market.

II. Working of the Participatory Notes

2 SEBI (Foreign Portfolio Investors) Regulation 2014.
3

India based brokerage houses buy Indian securities on behalf of foreign investors such as
Hedge Funds and issue PNs to them. This PN is basically a contract between foreign investor
and broking entity which assumes the responsibility of trading on behalf of the foreign
investor. This is illustrated below:-

SINGAPORE BASED
INVESTOR

BUYS X SHARES

Issues Participatory Notes with

X shares as underlying assets

FOREIGN BROKING HOUSE

(SINGAPORE)

BUYS X SHARES

Confirmation of shares purchased

FOREIGN BROKING HOUSE

(INDIA)

X SHARES

As seen in the chart above, the Singapore based foreign investor has issued a buy order for
certain X shares. This buy order has been given to local Singaporean broking house, which in
turn has relayed the instructions for execution of buy orders to its office based in India. The
India based broking house executes the buy order and confirms the same to its parent office
in Singapore. The broking house in Singapore then issues Participatory Notes to the investor,
with X shares as underlying assets. Subsequently any dividends or capital gains collected
from the underlying instruments flow back to the investors via the India based brokerage
house.

III. Reasons for the origin of Participatory Note route

i) Anonymity: Any entity investing in participatory notes is not required to register with SEBI
(Securities and Exchange Board of India), whereas all FIIs have to compulsorily get
registered. It enables large hedge funds to carry out their operations without disclosing their
identity.
ii) Ease of Trading: Trading through participatory notes is easy because participatory notes
are like contract notes transferable by endorsement and delivery.
iii.) Tax Saving: Some of the entities route their investment through participatory notes to
take advantage of the tax laws of certain preferred countries.3
iv.) Money Laundering: PNs are becoming a favourite with a host of Indian money launderers
who use them to first take funds out of country through hawala and then get it back using
PNs.
v.) P-notes are not necessarily just for the India market. In general terms, p-notes are used for
any market/share classification whereby there are restrictions for foreign investors (i.e.
require a Foreign Investor-type license for non-locally domiciled brokerages). The notable
markets include Shenzhen and Shanghai for China A-shares, some MENA markets and Korea
in addition to India.

IV. Concerns which sparked the debate over Participatory Notes

i) Being derivative instruments and freely tradable, PNs can be easily transferred, creating
multiple layers, thereby obfuscating the real beneficial owner. It is in this respect that
concerns about the identity of ultimate beneficial owner and the source of funds arises.
ii) The alleged use of PN route to bring back unaccounted funds.
iii) It is alleged that these instruments are traded overseas outside the direct purview of Sebi
surveillance, thereby raising many apprehensions about the beneficial ownership and the
nature of funds invested in these instruments. Concerns have been raised that some of the

3Swadesh Singh, SEBI tightens reporting norms for participatory notes Business Standard (Mumbai,
9 June 2012 ) <www.thehindubusinessline.com/news/sebi-tightens-reporting-norms-for-p notes
>accessed 11 October 2015.
5

money coming into the market via PNs could be unaccounted wealth camouflaged under the
guise of FII investment.
Concept of Beneficial Ownership
The concept of beneficial owner can be best defined as, the person who can ultimately
exercise rights of ownership in the property, as held by J. Hart in Cowan v. Nova Scotia 4 :
It seems to me that the plain ordinary meaning of the expression beneficial owner is the
real or true owner of the property. The property may be registered in another name or held in
trust for the real owner, but the beneficial owner is the one who can ultimately exercise the
rights of ownership in the property.
This understanding was approved in the recent Canadian case of Prvost Car Inc. v. R.5The
Tax Court of Canada held that the beneficial owner is the person who receives the dividends
for his or her own use and enjoyment and assumes the risk and control of the dividend he or
she has received. The Court further went on to explicitly state that it is the true owner of the
property who is the beneficial owner of the property. A similar view was also echoed by the
UK Court of Appeals in the case of J. Sainsbury PLC v. OConnor,6 where the Court
described the concept of beneficial ownership in the following manner:
The expression beneficial ownership is certainly one which has for several centuries had a
very well recognized meaning amongst property lawyers. And there can be no doubt that
Parliament must have intended to adopt that meaning. It means ownership for your own
benefit as opposed to ownership as trustee for another. It exists either where there is no
division of legal and beneficial ownership or where legal ownership is vested in one person
and the beneficial ownership or, which is the same thing, the equitable interest in the property
in another. Thus. a beneficial owner is someone who has the full right to use and enjoy an
asset, and is in substance unconstrained by any obligation to pass the payment received to
another person. This use and enjoyment, however, is to be distinguished from legal ownershi

4[1955] 1 Q.B. 158.

5[1950] 2 K.B. 86.
6[1919] 2 K.B. 198.
6

V. Use of Participatory Note Route in India

PNs became a conduit for international investment in India since their inception around
1992.7 In spite of the fact that the official rules on FIIs were released in 1995, these
instruments were attractive for investors who were apprehensive, yet interested to enter the
emerging Indian market. Theses instruments provide easy access to the Indian market. If an
investor would like to buy securities or derivatives, he sends his order to the FII. This FII
then conveys that order to his broker in India, who actually buys the securities. In return, PNs
are issued to the FII, who then passes them on to its clients.8 Apart from its ease of use, there
are other factors that made a case for the creation of PNs. These instruments were freely
tradable, which provided liquidity in the market. This liquidity was much required in the
recently and partially liberalized Indian market. Participatory Notes provided a method for
Mauritian individuals and companies to take advantage of the zero Capital Gains Tax
accorded by the Double Taxation Avoidance Agreement (DTAA). 9 This concept has been
explained hereinafter:A. Double Tax Avoidance Treaty: Double taxation is a situation in which two or more taxes
need to be paid for the same asset, financial transaction and/or, income and arises due to
overlap between different countries tax laws and jurisdictions. The liability is often mitigated
by tax treaties between countries.
It is not unusual for a business or individual who is resident in one country to make a taxable
gain (earning/profit) in another country. The person may find that he is obliged by domestic
laws to pay tax on that gain locally and pay again in the country in which the gain was made.

7Manmohan Singh , Use of Participatory Notes in Indian Equity Markets and Recent Regulatory Changes
[2007] IMF Working Paper 07/291, <https://www.imf.org/external/pubs/ft/wp/2007/wp07291.pdf> accessed 28
September 2015.

8C.P.Chandrasekhar, Courting Risk: Policy Manoeuvres on FII Inflows, Economic and Political Weekly
(2006): 92-95.

9Manmohan Singh , Use of Participatory Notes in Indian Equity Markets and Recent Regulatory Changes
[2007] IMF Working Paper 07/291, <https://www.imf.org/external/pubs/ft/wp/2007/wp07291.pdf> accessed 28
September 2015.

Since this is inequitable, many countries make bilateral double taxation agreements with each
other.
For ex. a large number of FIIs who trade on Indian stock market through Participatory Notes
route operate from Mauritius. According to the Double Taxation Avoidance Treaty between
India and Maurituis, capital gains arising from the sale of shares are taxable in the country of
residence of the shareholder and not in the country of the residence of the company whose
shares have been sold. Therefore a company based in Mauritius selling shares of an Indian
company will not pay tax in India. Since there is no capital gains tax in Maurituis, the gain
will escape tax altogether.
Moving further, it is pertinent to point out that investing through this instrument i.e. through
PN Route also significantly lowered the cost of entry into the Indian markets. Some of these
costs include, the money required to establish broker or bank relations, costs associated with
FII registration and subsequent disclosures, and costs associated with foreign exchange. 10 In
the context of the aforementioned cost advantages over FIIs, one can deduce the higher
premium of an individual transaction through PNs versus FIIs. Similarly, some of the other
advantages of PNs are just one side of a double-edged sword.
B. Disproportionate Inflow due to DTAA: The first issue with PNs was the capital gains
tax arbitrage opportunities that were created as a result of the DTAA. Onshore investors had
to pay taxes up to 40% on short-term capital gains, compared to 0% in Mauritius. This led to
an increase in the number of offshore firms that registered in the country. Additionally,
certified residents of Mauritius also had to pay minimal corporate tax, and therefore
companies began routing their investments in India through Mauritius.11 Between April 2000
and March 2011, Mauritius (41.8%) and Singapore (9.17%) accounted for over half of the
cumulative FDI in India.12 These disproportionate inflows occur even though 8 years of the
data set is cut out, and some arbitrage opportunities were nullified by 2004, through the
10 Report of the Expert Group on Encouraging FII Flows and Checking the Vulnerability of
Capital Markets to Speculative Flows, Government of India, Ministry of Finance,
Department of Economic Affairs [2005] p 16 <
http://finmin.nic.in/the_ministry/dept_eco_affairs/capital_market_div/ReportEGFII.pdf>
last accessed 16 September 2015.

11Manmohan Singh, Use of Participatory Notes in Indian Equity Markets and Recent Regulatory Changes
[2007] IMF Working Paper 07/291 <https://www.imf.org/external/pubs/ft/wp/2007/wp07291.pdf> accessed 28
September 2015.

decrease in the tax rate on Indian onshore Capital Gains and the increase in the cost of setting
up an establishment in Mauritius.
C. RBIs Suggestion to Ban the PN Route: An organization that was against PNs from the
start was the RBI. In its dissent of the Expert Group on FIIs, the RBI suggested winding
down all PNs and ceasing further issues. They said that the suspicious and anonymous nature
of the cash flows should be reason enough to shut PNs down. The anonymity could get
further magnified once PNs are traded between foreign investors through a process they call
multi-layering.13 This made it almost impossible to monitor entry into the Indian Market. In
2004, SEBI passed directives to curb these issues. They decreed that PNs could only be
issued to regulated bodies. However, it was downplayed as a mere strengthening of Know
Your Client (KYC) norms. SEBI rejected RBIs proposal to ban PNs because they believed
the financial community would have seen it as a recessive measure.14
D. Issue of Round Tripping: One problem that the government did not fix during the
2004 amendment was the plausibility of Round-tripping. Round-tripping is the process by
which tax-free illicit or black money leaves India through illegal routes, and is then
repatriated to the country with minimal fees. Since the official definition of regulated bodies
includes an individual or entity whose investment advisory is regulated, PNs provide a
perfect path to bring prodigal money back into the country. The least probable issue, although
still plausible, is the use of PNs by terrorists. High net worth terrorists could purchase PNs
through their asset managers, and then gift the notes as payment, without paying any tax on
the transfer. In spite of a longitudinal cross-section of society raising concerns about
Participatory Notes, they are still traded in the market today.

VI. Regulatory Timeline

12Swadesh Singh, SEBI tightens reporting norms for participatory notes Business Standard
(Mumbai, 9 June 2012 ) <www.thehindubusinessline.com/news/sebi-tightens-reporting-norms-for-p
notes > accessed 11 October 2015.
13 Mohan Ram, Neither Dread Nor Encourage Them., Economic and Political Weekly (2006): 95-99.
14 Vasudevan, A Note on Portfolio Flows into India Economic and Political Weekly (2006): 90-92.
9

To understand the current position with respect to participatory notes, it is of utmost

importance to be cognizant of the regulatory past. Participatory notes have caused friction
with regulators in the countries that it exists. Taiwan introduced strong disclosure
requirements for PNs in December 1999, but they rescinded those regulations 6 months
later.15
The rules on PNs in India have been shaped by the regulatory changes in the past. The idea of
an offshore instrument for investment in Indian securities probably stems from the Double
Taxation Avoidance Agreement with Mauritius. However, PNs first came into existence when
the economy opened up in 1992.16 In conjunction with the Foreign Exchange Regulation Act
(FERA) of 1973, the Government of India guidelines released 14 th September 1992 provided
a framework for foreign investment in India. 17 The official guidelines for PNs came out in
1995 as part of SEBIs rules on FIIs. Since then there have been a number of amendments to
the rules, but only a few of them have significantly affected PNs.
A. Requirement of KYC Compliance
In January 2004, SEBI stipulated that PNs are not to be issued to any non-regulated entity,
and the principle of "know your clients" (KYC) must be strictly adhered to. SEBI has
indicated that the existing non-eligible PNs will be permitted to expire or to be wound-down
on maturity, or within a period of 5 years, whichever is earlier. Besides, reporting requirement
on a regular basis has been imposed on all the FIIs. Policy options on PNs include:
(1) Winding down non-eligible PNs within three years instead of five years.
(2) Winding down all existing PNs within five years.
(3) Removing eligibility criteria for PNs.
B. Participatory Notes Crisis of 2007

15 Mohan Ram, Stock market fall: Managing volatile flows, Economic and Political Weekly (2006): 11-13.
16Swadesh Singh, SEBI tightens reporting norms for participatory notes Business Standard (Mumbai, 9 June
2012 ) <www.thehindubusinessline.com/news/sebi-tightens-reporting-norms-for-p notes > accessed 11 October
2015.

17 Kothari Rohan, The Impact of Participatory Notes on the Indian Rupee Exchange Rate [2013].
CMC Senior Theses. Paper 654 < http://scholarship.claremont.edu/cmc_theses/654> accessed 15
October 2015.
10

On the 16th of October, 2007, SEBI (Securities & Exchange Board of India) proposed curbs
on participatory notes which accounted for roughly 50% of FII investment in 2007. SEBI was
not happy with P-Notes because it is not possible to know who owns the underlying securities
and hedge funds acting through PNs might therefore cause volatility in the Indian markets.
However the proposals of SEBI were not clear and this led to a knee-jerk crash when the
markets opened on the following day (October 17, 2007). Within a minute of opening trade,
the Sensex crashed by 1744 points or about 9% of its value - the biggest intra-day fall in
Indian stock-markets in absolute terms.
The SEBI chief, M.Damodaran held an hour-long conference on the 22nd of October to clear
the air on the proposals to curb PNs where he announced that funds investing through PNs
were most welcome to register as FIIs, whose registration process would be made faster and
more streamlined. The markets welcomed the clarifications with an 879-point gain its
biggest single-day surge on October23, thus signaling the end of the PN crisis. SEBI
issued the fresh rules regarding PNs on the 25th of October, 2007 which said that FIIs cannot
issue fresh P-Notes and existing exposures were to be wound up within 18 months.
C. Position with respect to Participatory Notes prior to SEBI 2011 Circular
On P-notes prior to 2011, SEBI didn't have any means to know who is the end
investor or the person holding the note on a given date or who he has
transferred it to. SEBI thought that this is a matter of risk and worry. So SEBI amended its
regulations.
D. SEBI Circular dated January 07, 201118
The FIIs issuing ODIs/PNs shall be now be required to provide information about their ODI/PN
activity and their underlying trade(s) activity in India. The reports will have to be submitted by 10 th of
every month with a six months lag. The reports shall now be submitted with the following revised
undertaking:We undertake that the beneficial owner and the person(s) to whom the Offshore Derivative
Instrument is issued in compliance with Regulation 15A of SEBI (FII) Regulations. We also undertake
that the KYC compliance norms have been followed for the beneficial owner of the Offshore
Derivative Instrument
18SEBI Circular No.-CIR/IMD/FIIC
11

Thus in a nutshell it can be stated that this circular provides that its obligatory for the FIIs to
provide information about Participatory note transactions.
E. SEBI Circular dated June 07, 201219: FIIs issuing ODIs/PNs shall submit details of ODI/PN transaction report (Annexure A, B

and C) along with the monthly summary report by 10 th of every month for previous month`s
ODI transactions.
Thus SEBI ordered FIIs to report monthly details of P-notes transactions within 10 days.
Earlier, FIIs were given a time of six months for such reporting. This move came just a few
weeks after Govt. of India's white paper on black money identified P-notes as one of the
routes through which black money transferred outside India comes back through a process
called round-tripping.20

F. SEBI (Foreign Investment Portfolio Investors) Regulation 2014.

FPI regulations in 2014, have put further restrictions on who can issue PNs (participatory
notes) and who can subscribe to a PN.
22. (1) No foreign portfolio investor may issue, subscribe to or otherwise deal in offshore
derivative instruments, directly or indirectly, unless the following conditions are satisfied:
(a) such offshore derivative instruments are issued only to persons who are regulated by an
appropriate foreign regulatory authority;
(b) such offshore derivative instruments are issued after compliance with know your client
norms:
Provided that those unregulated broad based funds, which are classified as Category II
foreign portfolio investor by virtue of their investment manager being appropriately regulated
shall not issue, subscribe or otherwise deal in offshore derivatives instruments directly or
indirectly:
Provided further that no Category III foreign portfolio investor shall issue, subscribe to or
otherwise deal in offshore derivatives instruments directly or indirectly.
19SEBI Circular No.-CIR/IMD/FIIC/14/2012.
20Swadesh Singh, SEBI tightens reporting norms for participatory notes Business Standard
(Mumbai, 9 June 2012 ) <www.thehindubusinessline.com/news/sebi-tightens-reporting-norms-for-p
notes > accessed 11 October 2015.
12

(2) A foreign portfolio investor shall ensure that further issue or transfer of any offshore
derivative instruments issued by or on behalf of it is made only to persons who are regulated
by an appropriate foreign regulatory authority.
(3) Foreign portfolio investors shall fully disclose to the Board any information concerning
the terms of and parties to off-shore derivative instruments such as participatory notes, equity
linked notes or any other such instruments, by whatever names they are called, entered into
by it relating to any securities listed or proposed to be listed in any stock exchange in India,
as and when and in such form as the Board
may specify.
(4) Any offshore derivative instruments issued under the Securities and Exchange Board of
India (Foreign Institutional Investors) Regulations, 1995 before commencement of these
regulations shall be deemed to have been issued under the corresponding provision of these
regulations.
G. SEBI Circular dated November 24, 201421
SEBI said foreign portfolio investors shall issue ODIs only to those investors who are
residents of a country whose securities market regulator is a signatory to International
Organization

of

Securities

Commissions

(IOSCO)

multilateral

memorandum

of

understanding or a signatory to bilateral memorandum of understanding with SEBI.Else, the

applicant should be a bank, registered in a country whose central bank is a member of Bank
for International Settlements, and the applicant should not be from a country that has been
declared to have deficiencies in anti-money laundering or combating the financing of
terrorism, and has not addressed these deficiencies. Before this circular, even unregulated
overseas funds were allowed to subscribe to the Participatory Notes as long as the fund
manager was regulated. Basically, the new norms will enhance KYC and shut out entities
form opaque and non-transparent structure to filter the kind of money that flows into the
country.
H. Recommendations of the SIT
On 24th July,2015, the Supreme Court appointed Special Investigation Team (SIT) on Black
Money gave the following recommendations in its third SIT Report22:-

21SEBI Circular No. - CIR/IMD/FIIC/ 20 /2014.

13

i) It is clear that obtaining information on beneficial ownership of P notes is of crucial

importance to prevent their misuse. SEBI needs to examine the issue raised above and come
up with regulations where the final beneficial owner of P notes/ODIs are known.
ii) The information of beneficial owner with SEBI should be in form of individual whose
KYC information is known to SEBI. In no case should the KYC information end with name
of a company. In case a company is the holder of P notes/ODIs, SEBI should have
information of its promoters/directors who exercise effective control over the company. In
case of Companies/Trusts represented by service providers like lawyers/accountants SEBI
should have information on the real owners/effective controllers of those Companies/Trusts.
not end with name
iii) P notes are transferable in nature. This makes tracing the true beneficial owner of P
notes even more difficult since layering of transactions can be made so complex so as to
make it impossible to track the true beneficial owner. SEBI needs to examine if this
provision of allowing transferring of P notes is in any way beneficial for easing foreign
investment. Any investor wanting to invest through P notes can always invest afresh through
an Foreign Portfolio Investor (FPI) instead of buying from a P note holder.

VII. Suggestions
It is clear from the above discussion it is clear that participatory note is indeed a sensitive
topic for government, investors and SEBI. Any sudden change in the law pertaining to P
Notes isnt accepted easily by the market and hence SEBI has to be extra careful in dealing
with P- Notes. The following points should be considered by the SEBI while formulating the
P-Note policy:1) P-Notes should be accepted unless and until SEBI has full information about their
origin. This will ensure that they are not used for bringing black money in India.
2) A limit should be put upon the inflow of P-Notes. However, a complete ban on them
is not possible since it would lead to crashing of the stock market.
22 Rosemary Abraham , Participatory Notes, <http://www.arthapedia.in/index.php?
title=Participatory_Notes_(PNs) > accessed 10 September 2015.
14

3) The investment via this route has been declining in the three years. Still, India is
getting ample amount of foreign investments from other sources. Hence, Indian
economy can work efficiently even if the use of P-Note is diluted.
4) Currently P-Notes are mostly regulated by the SEBI FPI regulations and there is no
separate regulation or law for them. In fact there is no specific definition of a P-Note
and they are categorised as offshore derivative instruments. A separate regulation or
law for regulation P-Notes might help in effectively dealing with the P-Notes issue
and would go a long way in ensuring protection against their alleged misuse.
5) SEBI with the finance ministry's support, should insist on making public precise
information on the extent of leverage, types of derivatives used, and gross, net and
mark-to-market credit exposures embedded in P-notes.

VII. Conclusion
SEBI has tightened rules governing issuance of offshore derivative instruments (ODI),
popularly referred to as participatory notes (P-Notes). The move is seen by experts as an
attempt to ensure legitimate money flowing into the country and can be seem as the
regulators efforts to identify and monitor the beneficial owners of the shares held as closely
as possible. Before such regulations were initiated by the SEBI, even unregulated overseas
funds were allowed to subscribe to Participatory Notes as long as the fund manager was
regulated. The new norms introduced by the SEBI will indeed enhance the KYC and shut out
entities from opaque and non-transparent structure to filter the kind of money that flows into
the country.
SEBI has initiated an internal study of suggestions made by the Supreme Court-appointed
SIT on black money. This comes at a time when SEBI has already acted against over 950
domestic entities for suspected tax evasion through stock exchange platform, while at least 25
offshore entities are under its scanner for providing investment services to corporates and
High Networth Individuals (HNIs) here in a clandestine manner. These offshore units set up
in global financial hubs, including those linked to a few large European banks as also
boutique investment service providers run by persons of Indian origins, are offering hybrid
15

financial products to their clients in India while avoiding any regulatory oversight. While
norms have been tightened considerably for P-Notes over the years, they remain popular
among foreign investors since they allow them to invest in Indian markets without
undergoing the significant cost and time implications of directly investing in India.
I would like to conclude by stating that even though capital inflow by foreign investors is a
boon for a developing nation like ours, yet, we must have "sufficient checks and balances" on
such capital inflows. With regard to P-Notes, the regulator has indeed put in place a strong
deterrence to check any misuse of participatory notes and these can be issued only by wellregulated overseas entities such as sovereign wealth funds and pension funds of foreign
governments. At the same time we cannot ignore that any serious move to clamp down the P
Note Route might lead to huge outflow of foreign funds . SEBI should focus of developing
such a mechanism wherein the foreign capital inflow must not be hindered subject to the
compliance of all the SEBI Regulations. Also, SEBI must not hesitate in taking necessary
action against the Indian companies as well as the foreign entities found to be in violation of
its norms.

VIII. Bibliography
Articles
1. R. Vaidyanathan, Why Participatory Notes are dangerous Business Line (Delhi, 24
October 2007) http://www.thehindubusinessline.com/todays-paper/why-participatorynotes-are-dangerous/article1672845.ece accessed 12 October 2015.
2.

SEBI to ban participatory notes Financial Express (Mumbai, 17 October 2007)

http://archive.financialexpress.com/news/sebi-to-ban-participatory-notes/229281
accessed 10 October 2015.

3.

S.K Lokeshwari, The fading allure of P-notes Business Line (Delhi, (29 January
2011)

<http://www.thehindubusinessline.com/todays-paper/tp-opinion/the-fading-

allure-of-pnotes/article2327342.ece> accessed 11 October 2015.

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4.

Swadesh Singh, SEBI tightens reporting norms for participatory notes Business
Standard (Mumbai, 9 June 2012) <www.thehindubusinessline.com/news/sebitightens-reporting-norms-for-p notes> accessed 3 October 2015.

Reports
1. 255th Report of the Law Commission of India, 2015
2. Report of the Expert Group on Encouraging FII Flows and Checking the Vulnerability
of Capital Markets to Speculative Flows, Government of India, Ministry of Finance,
Department of Economic Affairs, New Delhi
Statutes, Regulations Referred
1. Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act,
2015
2. Income Tax Act, 1961
3. SEBI Foreign Portfolio Investment Regulations 2014
4. SEBI Foreign Institutional Investors Regulations 1995

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