In a proposal aimed at curbing misuse of participatory notes (P-notes), the Securities and Exchange Board of India’s (Sebi) has proposed to tighten rules on P-notes and similar offshore derivative instruments (ODIs) by imposing regulatory fees and prohibiting the sale of such products for speculative purposes. The market regulator, in a consultative paper, proposed a fee of $1,000 every three years, starting from April 1 this year, on ODI issuers and each investor, in order to “discourage the ODI subscribers from taking the ODI route” and push them instead to register as foreign portfolio investors.
It has proposed to prohibit ODIs from being issued against derivatives for speculative purpose. The ODI issuers would be given time till December 31, 2020, to wind up the ODIs issued against derivatives which are not for hedging purpose. “It will be incumbent on ODI issuing FPI to ensure that ODI is issued against those derivatives which are purely for hedging purpose and not for naked speculation. The ODI issuing FPI shall put in place necessary system to ensure the same,” Sebi said.
ODIs are currently being issued against derivatives along with equity and debt. As of April 2017, the ODIs issued against derivatives had a notional value of Rs 40,165 crore, which is 24 per cent of the total notional value of outstanding ODIs. The value of foreign investments through P-notes or offshore derivative instruments has already fallen to a four-month low of about Rs 1.68 lakh crore.
P-notes are ODIs issued by registered foreign portfolio investors (FPIs) to overseas investors who wish to be a part of the Indian stock markets without registering themselves directly. Though P-note holders have less stringent registration requirements, they will have to go through a proper due diligence process of the Sebi. Last month, the board of Sebi had tightened the norm by barring resident Indians, NRIs and entities owned by them from making investment through P-notes.
The Sebi has said its proposals were being made “to enhance the transparency in the process of issuance and monitoring of ODIs,” and set a June 12 deadline for comments from interested parties. While rules governing P-notes were tightened over a period of time, there are still concerns that P-Notes are misused by some operators to channelise black money from abroad into the country through the stock markets.
The regulator said it has been continuously making regulatory changes in order to ensure that the ODI route is not misused. “These changes however, require investment in manpower and systems in order to make quick analysis of the voluminous data being submitted by the ODI issuing FPIs. Sebi incurs a significant expenditure in terms capital and manpower when it comes to monitoring of investments coming through the ODI route. Sebi has put in place dedicated IT systems for the ODI issuers to report the Beneficial Owners and other details of the ODI subscribers. We may therefore, levy regulatory fees on FPIs issuing ODIs and the group entities of such FPIs, which may be involved in taking underlying positions in Indian securities market,” the Sebi paper said.
Sebi said many ODI subscribers invest through multiple issuers and the proposed fee will discourage the ODI subscribers from taking ODI route and encourage them to directly take registration as an FPI.