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Why govt should smile at Participatory Notes

To ensure a steady steam of foreign inflows,a ready solution is to bless P-Notes as a legit route for investment

Published: August 12, 2013 12:00:33 am

We are in the midst of severe competition among emerging markets to attract foreign investment. Therefore greater the certainty in the regime of rules greater is the attractiveness of a country and conversely if investors perceive a ‘commitment deficit’,fear and liquidation of investments follows. Let us also accept that to a foreign investor India is one among several destinations competing for its dollar. This has always been the mind of an investor.

Ensconced in the existing regime is an instrument called Participatory Note (PN),legally enshrined as Offshore Derivative Instrument(ODI).

Investments through PNs have waxed and waned to the tunes of the piper. In 2007,the now unthinkable happened – the INR-USD hit 39 on the back of a flood of foreign investments; a cap on investments through PNs at 40 per cent of assets under management closely followed.

Foreign Institutional Investors (FIIs) were frowned upon for running a borrowing and lending book outside India. PNs were blamed for hiding the identity of investors and allegations of round tripping were levied. The celebrated case of an FII denying information to the regulator was settled in the Supreme Court with the powers to call for information intact.

Fast forward to today. At Rs 60 to the US dollar,India is back to the wall,hoping the thin stream of foreign inflows would swell yet again. A ready solution is to polish the PN regime with a coat of certainty and bless it as an equally legit route for investment in India as much as any other that is on offer. Why the government of India should take such a step even if it is one of optics or rebranding,is due to two milestone events took place between 2007 and today:

1. India became a member of the FATF (Financial Action Task Force) — a global standard setting body in the fight against money laundering and financing of terror — and joined 34 other countries in this club.

2. The FIIs that issue PNs being regulated entities in India and in their respective home jurisdictions,were brought under a strict regime of reporting.

Let me expound on the implications of these events. As part of its commitment to the FATF,India enacted the Prevention of Money Laundering (PML) Act and rules followed by OEMs (other enforceable means) issued by sectoral regulators.

The concept of ‘beneficial ownership’ has become an integral part of the lexicon. India was recently validated by FATF to have adequately completed its promised actions,among which is placing the onus on regulated entities to conduct Client Due Diligence (CDD) in order to ascertain beneficial ownership as well as ‘control’ embedded within the structure of its client.

On-going CDD involves monitoring sources of income and wealth of the client and setting off alarm bells in case of suspicions. This applies equally to accounts held by FIIs wherein PNs have been issued. There is no reason why an account opened by a regulated entity in its home territory should be looked upon differently than one opened here,when both jurisdictions are signatory members of the FATF.

The implication is that past fears about the type of money and its ownership are not relevant or pertinent today since money entering India has passed the test of CDD in an Foreign Investment Promotion Board (FIPB) member country. In fact,the recent news on FIPB raising queries due to absence of beneficial ownership details appears straight out of the PML Rulebook and rightfully so.

The information about beneficial holders of PNs is uploaded on a periodic basis to the regulator. The additional mandatory conditions that could be imposed before the government of India truly smiles at PNs are that FIIs must perform a role of ‘execution only’ for any buy,sell,borrow or lend order of a PN client and that the bank account of PN holders must be located in an FATF member country.

The onus of tax and regulatory compliances arising from investing in India is on the FII; the PN holder bears the economic implications of the same. The PN holder therefore does not worry about obtaining a PAN or engaging tax services. The universal model of prime broking with all attendant conditions is thereby activated for channelising investments to India.

It was once stated that India will look like another emerging market in south-east Asia only when a desire to take exposure on India can be executed within a couple of hours. Step back and enquire of your kith and kin holding foreign nationality the quickest and hassle-free way of taking an exposure on Indian capital markets.

A likely answer will be investment through a PN contract with the local bank where they own an account ie KYC compliant. Surely such money coming into India is not tainted. This is how investments are carried out in several parts of the world. Should we be any different? The two-hour goal for investment in India and its competitive edge would be realised.

The author is a civil servant and ex-ED,Sebi. Views expressed are personal.

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