The rules governing participatory notes may be relaxed with the Reserve
Bank of India initiating a review in consultation with Sebi and the
government. Non-resident Indians could soon have the additional option
of investing in Indian capital markets through this method. PN is a
derivative instrument used by a foreign entity to invest in India even
without registering itself with the Indian regulator. The user can be
a Foreign Institutional Investor (FII) registered with the Securities
and Exchange Board of India (Sebi), its sub accounts, hedge funds, pension
funds among others. PNs are popular with NRIs for three main reasons:
1. Anonymity - Investors do not have to disclose their identity to Sebi;
2. Simplicity - All the legal paperwork is handled by FIIs, and 3. Tax
benefit - Unlike Indians, overseas investors do not have to pay the
33 per cent tax.
In the recent past, a lot of coverage has been given to participatory
notes and they have become a matter of concern for regulatory bodies
in India. They have always generated lot of debate and controversy in
the financial markets circle. The participatory notes were responsible
for largest fall witnessed ever in Indian stock markets. Foreign investments
in the Indian markets, especially NRI
investments, have seen a huge increase in recent times.
PNs are derivative instruments used by foreign investors to invest in
the Indian stock markets. Various options are being explored to relax
the norms with proper checks and balances for ascertaining the quality
and the sources of funds coming through this route. One of the options
being considered is to open up the investment route for non-resident
Indians who could either invest through an FII or the PN route. The
initiative to relax the PN route is a major shift in RBI's stance as
the central bank has all along been advocating a ban on investments
through PNs in view of the opaque nature of the instrument which makes
it difficult to assess the quality of the funds.
FIIs who are registered with Sebi issue PNs to overseas investors
who wish to invest their funds in the Indian stock market without disclosing
their identity to Sebi. FIIs inform overseas investors about the details
of the securities, expected rate of return and more. On this basis,
if the foreign investors decide to invest in the particular equities,
they are required to deposit funds in the foreign branches of the FII.
The FII, on its part, purchases the selected scrips in the Indian market
and takes care of all the legal formalities. Although FIIs have contributed
to the Indian economy, in more ways than one, they have not been able
to earn the respect they should have. The concerns of the regulators
are not without reasons. In fact their concerns are very genuine and
in the larger interest of the Indian markets. The feeling of the regulators
that PNs can be used to destabilise the market and can be a strong source
of funding for terrorist outfits is very true.
The Indian financial markets can become a haven for money launderers,
smugglers, drug traffickers and for anti-national elements if the route
of participatory notes remains largely unregulated. Further, it can
be used to destabilize the economy and to create artificial crisis in
the market considering the fact that PNs constitutes major chunk of
FIIs inflow into India. Moreover, it can be used as an instrument to
evade taxes, promote benami transactions, running parallel economy and
most importantly act as an attractive source of investment for mafias
and underworld. Under the present situation, the investment pattern
of PNs does not satisfy the criteria of fair play. The Government has
to give serious thought to the entire matter as it is closely related
with our financial markets development as well with national security
and peace. However, a cautious opening up along with proper checks and
balances can provide a major boost to the capital markets as more and
more FIIs and NRIs would definitely want to opt for a hassle-free participation
in India's success story.
