Why has SEBI barred NRIs and Indians from P-notes

The Securities and Exchange Board of India’s move barring NRIs and resident Indians from subscribing to offshore derivative instruments, also called P-notes, appears to be part of the larger war against black money.

The Special Investigation Team set up to unearth black money had expressed concerns over these opaque instruments being used as a channel by money-launderers.

In its board meeting held on Wednesday, SEBI stated that it will amend the Foreign Portfolio Investor (FPI) regulations to ensure that resident Indians, Non-Resident Indians and entities owned by them do not buy offshore derivative instruments or Participatory Notes (P-notes).

P-notes are derivative instruments issued by FPIs to investors outside India. These instruments could be drawn on stocks, debt or derivatives.

Both the Reserve Bank of India and SEBI have been worried that these instruments have been used by resident Indians for laundering black money.

The concern stems from the fact that these are transferable instruments. That is, the foreign investor who buys them from an FPI can transfer them to another foreign investor. Since the Indian regulator cannot effectively control transfers taking place outside the country, there had been rampant misuse in the past.

SEBI had tightened the rules governing these instruments to a large extent in 2008 and in the following years, to ensure better disclosure.

It had mandated that the onward issuances of P-notes be captured in the disclosure made by the FPI issuing the P-notes. The regulator had also made it mandatory for only regulated entities to be issued P-notes.

But despite tighter vigilance, there appears to be many loopholes that the wrong-doers can exploit.

The Pluri case, involving one of India’s largest companies and some large global investment banks, aptly highlights the vulnerabilities around these instruments.

Here are the contours of the case: Barclays had issued P-notes with the shares of Reliance Communications as the underlying asset to Hythe Securities. But in its periodic disclosure to SEBI, Barclays omitted to disclose that the same P-notes had been further issued to Pluri, an unregulated entity.

Societe Generale (SG) too made wrong disclosures to SEBI regarding the counter-party for issuing the P-notes. On further questioning regarding the end-beneficiary of the ODI, SG denied any knowledge of further issuance of the ODI stating that it was transacting only with Hythe on ‘principal’ basis.

On further scrutiny, Hythe confirmed that these P-notes were onward issued to Opportunite SA and further to Pluri.

While SEBI restricted its investigations to the transactions that took place in India, another set of investigation by the UK regulator revealed that Pluri Cell E was created by the Anil Ambani group through UBS.

The company’s money was being used to prop up the shares of Reliance Communications by routing it through P-notes.

The entire matter was settled through a consent order for a penalty of ₹50 crore. Two group companies, Reliance Natural Resources (RNRL) and Reliance Infrastructure, as well as Anil Ambani and some board members were banned from accessing the capital markets for two years.

P-notes are, however, no longer a threat to Indian markets. P-note issuance has decreased significantly since 2007, when these instruments made up almost 50 per cent of FII assets. Their share has dwindled, with outstanding P-notes at ₹1,78,437 crore at the end of March 2017.

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