Participatory Notes

there are 1,675 registered FIIs and 5,204 registered sub-accounts. the total share of P-note investments fell from 19.8 per cent in October 2008 to 15.5 per cent in June 2009. This implies that a majority of investments came from registered FIIs and their sub-accounts. P-note investments had hit peak in September 2007 at 51 per cent. Former Sebi Chairman M Damodaran had proposed to ban investments through P-notes in October 2007. P-notes also expose the holder to a counter-party risk, so at a time when a lot of large institutions were going bust, investors found it safer to come directly rather then expose 1.

1.

It keeps the investor anonymous

2.

It saves cost of record keeping, transaction cost, and regulatory compliance overseas especially for small investors.

3. Thus investor use PN to enter the Indian market in a small way and then when they are established, they shift to full-fleged FII structure.

2. What are the Problem with the instrument? It is tough to establish the beneficial

ownership or the identity of original investor. The investor may sell the PN to others, and thus further layers. PN is also becoming favorite with many Indian Money Launderers, who use it to first ship out money of country through Hawala and then get it back using PNs.

3. What is the extent to which PN's are used? Over the years the use of PNs have increased from 17 FII issuing it in 2005 to over 2 dozen funds now.Merrill Lynch, Morgan Stanley, Credit Lyonnais, citigroups and Goldman Sachs are the biggest issuers. Currently 51.4% of all assets under FII are under PN now a days 4.

What are P-Notes?

It may be recalled that the Securities and Exchange Board of India had first raised the issue of participatory notes through a circular in October 2001. The circular said some FIIs were issuing derivatives/financial instruments against underlying Indian securities. The circular had said these instruments were known by various names such as participatory notes, equitylinked notes, capped return notes and participating return notes. With a view to monitoring the investment by FIIs through participatory notes, Sebi had decided that FIIs must report details of these instruments along with the names of the holders of these instruments. In order to increase transparency, Sebi had in October 2001 issued a circular to all FIIs and their custodians advising them to report to the regulator as and when any derivative instrument with Indian underlying securities were issued/renewed/redeemed by them either on their own account or on behalf of sub-accounts registered with them. Accordingly, FIIs are sending reports from time to time whenever they are issuing PNs. The disclosures in the reports submitted by FIIs are to be enhanced. SEBI has ruled that FIIs holding P-notes that account for less than 40 per cent of their assets under custody (AUC) can issue further P-notes to increase the outstanding proportion to 40 per cent, but at an incremental rate of 5 per cent of AUC per year. However, FIIs with outstanding Pnotes exceeding 40 per cent of AUC on September 30, can issue fresh P-notes only on a cancellation or redemption of existing instruments.