Investment banks say tighter P-Note norms good, but not needed

Major foreign investors, including JPMorgan, HSBC, UBS and Goldman Sachs, have supported the proposed move by the Securities and Exchange Board of India (Sebi) to tighten reporting and compliance standards on P-Notes.

At the same time, these investment banks say a tightening of controls on P-Note issue is unlikely to be "resource effective" as the regulatory requirements for offshore derivative instruments in India are already more stringent.

They also sought to allay fears over a concentration of end-beneficial owners of P-Notes being located in Cayman Islands, which accounts for over 41 per cent of all such entities.

A meeting of the Sebi board on 20 May is expected to finalise the changes in P-Note norms, although some investors are of the view that the introduction of any further control measures would adversely affect resource flows into the country.

The proposed changes could include increased disclosure requirements on transfer and prior consent of issuer on transfer, bringing P-Notes under know-your-customer (KYC) and anti money laundering norms and reporting suspicious transactions to the financial intelligence unit.

The new proposals follow recommendations made by the Supreme Court (SC) appointed Special Investigation Team (SIT) on black money and are in line with amendments made in investment and tax treaty with Mauritius government.

The investment banks, however, sought to allay fears over offshore derivative instruments (ODIs), commonly known as Participatory Notes or P-Notes as a large chunk of end-beneficial owners of P-Notes are located in Cayman Islands, which accounts for over 41 per cent of all such entities.

In a representation before the capital markets regulator, the investment banks 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 say 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".

A Sebi study has found that while 41 per cent of P-Notes originate from Cayman Islands, Mauritius, the second-biggest location for end-beneficial owners of ODIs, accounts for only 11.09 per cent.

Other major locations include the UK and the US with over 10 per cent share each.

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.