Sebi tightens rules for P-Note issue

The Securities and Exchange Board of India (Sebi) has tightened rules relating to issuance of P-notes, also known as offshore derivative instruments (ODIs), after the FII inflows through the participatory note (P-note) route hit an 80-month high of Rs265,000 crore in October.

Sebi has aligned the applicable eligibility and investment norms between foreign portfolio investor (FPI) regime and subscription through the offshore derivative instruments (ODI) route in a bid to arrest the rush.
Accordingly, an FPI can now issue ODIs only to those subscribers, which meet the eligibility criteria as laid down in SEBI (Foreign Portfolio Investor) Regulations, 2014.

Under the Sebi Regulations, an FPI applicant will not be granted registration unless it is satisfied that the applicant is resident of a country whose securities market regulator is a signatory to the International Organisation of Securities Commission's Multilateral Memorandum of Understanding or a signatory to bilateral memorandum of understanding with the Sebi.

The applicant bank should be a resident of a country whose central bank is a member of the Bank for International Settlements (BIS).

Applicant banks resident in a country identified by the Financial Action Task Force as a jurisdiction deficient in addressing the strategic anti-money laundering measures or in combating financing of terrorism, to which counter measures apply or a jurisdiction that has not made sufficient progress in addressing the deficiencies or has not committed to an action plan developed with the Financial Action Task Force to address the deficiencies will not be eligible to issue P-Notes or ODIs,

An FPI may issue ODIs only to those subscribers, which do not have opaque structure(s), as defined under Sebi (Foreign Portfolio Investors) Regulations, 2014.

Sebi has clarified that these investment restrictions will apply to ODI subscribers as well. For this purpose, two or more ODI subscribers having common beneficial owner (BO) would be considered together as a single ODI subscriber, in the same manner as is being done in the case of FPIs.

Further, where an investor has investments as FPI and also holds positions as an ODI subscriber, these investment restrictions would apply on the aggregate of FPI investments and ODI positions held in the underlying Indian company. In other words, the investment as FPI and positions held as ODI subscriber will be clubbed together with reference to the said investment restrictions.

FPIs, which issue ODIs, should put in place necessary systems to ensure compliance with provisions as mentioned above, Sebi said.

Existing ODI positions, if they are not in accordance with these provisions, can continue till the expiry of the ODI contract. No additional issuances / renewal / roll-over of such positions would be permitted. Fresh issuance of ODIs can be made only to the eligible subscribers subject to the compliance with provisions of the new provisions and with Sebi (Foreign Portfolio Investors) Regulations, 2014 as also other applicable norms.

Sebi's move to tighten rules for participatory notes issuance by foreign institutional investors will make life tougher for those looking to avoid regulatory glare, although P-notes would continue to be a preferred route for round tripping / money laundering unless the regulator is able to show that it can track down the beneficial owners with minimum fuss wherever it suspects violations.

It is widely suspected P-notes are a conduit for bringing black money parked abroad, back into India.

P-notes are offshore derivative instruments issued by Sebi-registered FIIs to overseas investors who do not want to register with Sebi for reasons legitimate or devious. The registered FII buys shares / derivatives on behalf of the unregistered players, and issues P-notes (a receipt of sorts) since the ownership of those shares / derivatives cannot be transferred to the unregistered.