Are participatory notes staging a comeback?

PALAK SHAH Mumbai | Updated on August 21, 2019 Published on August 21, 2019

On Wednesday, markets regulator SEBI said: “...requirements for issuance and subscription of offshore derivative instruments (ODIs) have been rationalised.” ODIs are nothing but P-Notes, which have been under a cloud ever since the Narendra Modi government took power in 2014.

SEBI did not elaborate on what it meant by ‘rationalising’ requirements for issuance and subscription of ODI but experts say that it could only mean the regulator is no longer looking to clamp down on them. There is absolutely no room to tighten the norms on P-Notes further.

Legal experts expressed surprise at the move to rationalise ODI norms as the instruments are no longer widely used. This can only mean that SEBI was in favour of their revival in a controlled manner, experts said.

“ODI, which is P-Notes, was dead as an instrument mainly due to the clampdown by SEBI. There is no room for tightening of norms further on P-Notes. In that scenario, SEBI’s statement on Wednesday to ‘rationalise norms on ODIs’ could only mean that the regulator was easing them,” said a legal expert.

Another legal luminary clarified that per his knowledge, SEBI was working on norms that would specify that ODIs can be subscribed only by Category-I funds, which are mainly large FPIs (foreign portfolio investors) owned by banks or sovereign funds. Category-I FPIs come only from regulated jurisdictions. “SEBI should explicitly clarify on its statement as to what it means by ‘rationalising’ issuance and subscription of ODIs. Earlier, there was a perception that SEBI was completely against the use of PNs and they wanted FPIs to come and directly register. But now the ‘rationalising’ word used by SEBI could mean that it was in a mood to accept PNs if they were issued and subscribed by certain category of funds,” a lawyer said.

In 2007, nearly half of India’s ₹10-lakh crore worth of debt and equity positions by FPIs were held via P-Notes. The instrument had the lion’s share of the derivative positions and often caused massive volatility on derivative expiry.

After years of tightening, SEBI in August 2017 sounded the death knell for P-Notes. The regulator had said P-Notes could no longer be used except for the purpose of hedging. It made the definition of hedging for this purpose so narrow that it stole the charm of the instrument in the derivative segment. SEBI also imposed a fee of $1,000 on P-Note users.

Market players believe SEBI is wooing FPIs by simplifying their registration norms after they were hurt by Finance Minister Nirmala Sitharaman’s decision to impose a surcharge on capital gains tax.

FPI selling in India’s stock market had intensified after the July 5 presentation of the Union Budget. SEBI on Wednesday broad-based criteria for FPIs and eased KYC norms. FPIs will also be permitted to carry out off-market transfers of unlisted securities to domestic and foreign investors. Additionally, offshore funds floated by Indian mutual funds will now be permitted to invest in India after obtaining FPI registration.

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Published on August 21, 2019
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