Participatory notes

 Participatory Notes or P-Notes are financial

instruments that are issued by FII’s to investors
and hedge funds who wish to invest in Indian
stock markets, but who are not registered with
SEBI (Securities and Exchange Board of India).
 Why P-Notes ?
 Investments by nonresidents under the Portfolio Investment Scheme (i.e., through
the stock exchange) are permitted only as foreign institutional investments.
 For purposes of eligibility for investment under this route, a nonresident has to
register with the Securities & Exchange Board of India (SEBI) as a Foreign
Institutional Investor (FII) or as a sub-account of an existing FII.
 Registration as an FII requires fulfillment of various conditions prescribed by SEBI
(the entity has to be regulated by an appropriate regulatory authority overseas; it
should have a track record; it should fall within one of the prescribed categories,
etc.).
 Some of these investors do not want to register themselves with SEBI or, due to the
conditions prescribed for FII registration, are unable to register themselves as such.
 FIIs issue Participatory Notes to such overseas investors
 These instruments are termed Offshore Derivative Instruments (ODIs) since they
derive their value from the underlying Indian security
 The FII trades on behalf of such overseas investors and issues them ODIs such as
Participatory Notes
functioning OF p-notes
Singapore based Investor
Issues participatory
Buy X Shares notes with X shares
as underlying

Foreign Banking House(Singapore)

Confirmation of
Buy X Shares
Shares purchased

Foreign Banking House (India)

Buys

X Shares
Indian Capital Market
Following entities / funds are eligible to get registered as
FII:

Pension Funds
Mutual Funds
Insurance Companies
Investment Trusts
Banks
University Funds
Endowments
Foundations
Charitable Trusts / Charitable Societies
Which financial instruments are available for FII
investments?

Securities in primary and secondary markets including

shares, debentures and warrants of companies, unlisted,
listed or to be listed on a recognized stock exchange in
India;
Units of mutual funds;
Dated Government Securities;
Derivatives traded on a recognized stock exchange;
Commercial papers.
 Share of P-Notes in total FII Investment
*Total Value #Assets Under
Month of PNs Management of FIIs A as % of B
A B C
7-Jan 202487 581087 34.8
7-Feb 215675 537295 40.1
7-Mar 242839 547010 44.4
7-Apr 256896 591603 43.4
7-May 292113 632731 46.2
7-Jun 367330 659570 55.7
7-Jul 350026 709800 49.3
7-Aug 353484 685636 51.6
7-Sep 407690 799725 51
7-Oct 449613 936308 48
7-Nov 417936 938592 44.5
7-Dec 381120 1027141 37.1

#Assets Under
Management of A as
Month Total Value of PNs FIIs % of B
A B C
Jan-10 131938 814844 14%
Feb-10 124177 818894 13%
Mar-10 145037 900869 15%
Apr-10 154,340 927,194 15%
May-10 159,927 883,379 15%
Jun-10 168,016 927,468 15%
Source: http://www.sebi.gov.in/odi/ Jul-10 165,749 971,022 15%
 Who can subscribe to/invest in Participatory Notes?

 Any entity incorporated in a jurisdiction that requires filing of constitutional and/or

other documents with a registrar of companies or comparable regulatory agency or body
under the applicable companies legislation in that jurisdiction;
 Any entity that is regulated, authorised or supervised by a central bank, such as the
Bank of England, the Federal Reserve, the Hong Kong Monetary Authority, the
Monetary Authority of Singapore or any other similar body provided that the entity
must not only be authorised but also be regulated by the aforesaid regulatory bodies;
 Any entity that is regulated, authorised or supervised by a securities or futures
commission, such as the Financial Services Authority (UK), the Securities and
Exchange Commission (Sub-account), the Commodities Futures Trading Commission
(Sub-account), the Securities and Futures Commission (Hong Kong or Taiwan),
Australian Securities and Investments Commission (Australia) or other securities or
futures authority or commission in any country , state or territory ;
 Any entity that is a member of securities or futures exchanges such as the New York
Stock Exchange (Sub-account), London Stock Exchange (UK), Tokyo Stock Exchange
(Japan), NASD (Sub-account) or other similar self-regulatory securities or futures
authority or commission within any country, state or territory provided that the
aforesaid mentioned organizations which are in the nature of self regulatory
organizations are ultimately accountable to the respective securities / financial market
regulators.
 Any individual or entity (such as fund, trust, collective investment scheme, Investment
Company or limited partnership) whose investment advisory function is managed by an
entity satisfying the criteria of (a), (b), (c) or (d) above.
 What are the reporting Requirements for the FII / Sub-
account issuing Participatory Notes?

FII/sub-account who issue/renew/cancel/redeem PNs, require to

report on Monthly basis. The report should reach SEBI by the 7th
day of the following month.
The FII/sub-account merely investing/subscribing in/to the
Participatory Notes/Access Products/Offshore Derivative
Instruments or any such type of instruments/securities with
underlying Indian market securities are required to report on
quarterly basis (Jan-Mar, Apr-Jun, Jul-Sep and Oct-Dec).
FIIs/sub-accounts who do not issue PNs but have trades/holds
Indian securities during the reporting quarter (Jan-Mar, Apr-Jun,
Jul-Sep and Oct-Dec) require to submit 'Nil' undertaking on a
quarterly basis.
FIIs/sub-accounts who do not issue PNs and do not have trades/
holdings in Indian securities during the reporting quarter. (Jan-Mar,
Apr-Jun, Jul-Sep and Oct-Dec): No reports required for that
reporting quarter.
 P-Notes are issued to the real investors on the basis of
stocks purchased by the FII.
 The registered FII looks after all the transactions, which
appear as proprietary trades in its books.
 It is not obligatory for the FIIs to disclose their client
details to the Sebi, unless asked specifically.
 Morgan Stanley , Credit Lyonnais, Citigroup ,Goldman
Sachs, Macquarie and Standard Chartered Bank who are
registered in India with SEBI issue Participatory Notes.
Who can invest in P-notes?
 Any entity incorporated in a jurisdiction that requires filing of
constitutional and/or other documents with a registrar of
companies or comparable regulatory agency or body under
the applicable companies legislation in that jurisdiction
 Any entity that is regulated, authorised or supervised by a
central bank, such as the Bank of England , the Hong Kong
Monetary Authority, or any other similar body.
 Any entity that is regulated, authorised or supervised by a
securities, such as the Financial Services Authority (UK), the
Securities and Exchange Commission, Trading Commission,
the Securities and Futures Commission.
Cont…….
 Any entity that is a member of securities or futures
exchanges such as the New York Stock Exchange
(Sub-account), London Stock Exchange (UK),
provided that they are ultimately accountable to the
respective securities / financial market regulators.

 Any individual or entity (such as fund, trust,

collective investment scheme, Investment Company or
limited partnership) whose investment advisory
function is managed by an entity satisfying the criteria
of above.
How does it work ?

 FIIs who issue/renew/cancel/redeem P-Notes, are

required to report on a monthly basis. The report should
reach the Sebi by the 7th day of the following month.

 The FII merely investing/subscribing in/to the

Participatory Notes -- or any such type of
instruments/securities -- with underlying Indian market
securities are required to report on quarterly basis (Jan-
Mar, Apr-Jun, Jul-Sep and Oct-Dec)

 FIIs who do not issue PNs but have trades/holds Indian

securities during the reporting quarter (Jan-Mar, Apr-Jun,
Jul-Sep and Oct-Dec) require to submit 'Nil' undertaking
on a quarterly basis
Advantages of P-Notes
 Convenient for foreign investors, because participatory notes

are like contract notes transferable by approval

 P-note provide high degree of anonymity.

 Some of the entities want their investment through P notes to

take advantage of the tax laws of certain preferred countries.

 It is important source of investment in Indian capital market

 It strengthen rupee against the dollar.

 KYC NORM
"Know Your Customer” (KYC) procedure is the key principle for
identification of an individual/corporate opening an account.
 The customer identification should entail verification through an

introductory reference from an existing account holder/a person known

to the bank
 Or on the basis of documents provided by the customer.

 Came into existence after UBS scam.

The objectives of the KYC framework is:

(i) To ensure appropriate customer identification and

(ii) To monitor transactions of a suspicious nature.

 Role of P-notes in Indian security market

 Huge inflow of foreign funds into Indian stock market

 On April , 2003, a bearish market turned into a bull market

with index had jumped 55 % ,major reason for this was P-

notes and total contribution of FII was around 5 billion
 The contribution of participatory notes in 2003 was estimated

to be $ 1.5 billion and approx $ 9 bn in 2009

 P-Notes accounted for as much as 55% or more than half of

total inflow into India

 Cont…
 In 2005 P-notes rose dramatically from 30.6% in April (the

Sensex was 6,605 ) to 46.73% in August (the Sensex was

7,805 ) and it crosses 9000 in that year.
 Participatory notes account for over 42% pc of FII inflows till

Sep. 2009
Participatory Notes Crisis of 2007
 P-notes crisis took place on 16th of October, 2007

 proposals of SEBI were not clear and this led to a knee-jerk crash

 Sensex crashed by 1744 points in a single day.

 P.Chidambaram issued clarifications, that the government was not

against FIIs and was not immediately banning PNs

 Earlier, in October 2007, the Sebi had banned fresh issue of P-

Notes by FIIs. This was done to check the significant flow of

foreign funds into the Indian stock markets. The excess liquidity
was difficult for the financial market regulators to handle.
Whether participatory note be abolished?
 It is also called problematic note

 Capital market regulators dislike p-notes

 It gives rise to illegal activities.As it is associated with Benami

transaction which is not allowed in indian stock market

 The income tax deptt has proposed to tax participatory holders

 P-note creates a mirage that the market is booming

 UBS securities scam