Wednesday, October 17, 2007

Participatory Notes... an Introduction.

Yesterday, the Indian equity markets had a over 7% decline. The ostenible reason has that the SEBI (Securities and Exchange Board of India) issued a recommendation (position paper) to the Finance Ministry that Foreign Institutional/semi-Institutional Investors, or their sub-accounts, shouldn't be allowed to issue participatory notes where (a) derivatives are the underlying (b) the notional value of the participatory note is greater than 40% of assets under custody. It is useful to recap what participatory notes are in this context. (From the Hindu Business Line)

Participatory notes are like contract notes. These are issued by FIIs to
entities that want to invest in the Indian stock market but do not want to
register themselves with the SEBI. FIIs registered with the SEBI and their
sub-accounts can issue, deal, or hold P-Notes. The underlying security against
these notes would be listed or proposed-to-be-listed securities on any Indian
stock exchange. FIIs issue these notes to investors abroad with details of
scrips that can be bought and expected returns over specific periods of time. If
the client agrees, they deposit the funds with the overseas branch of the FII.
Then, the Indian arm of the FII proceeds with the transaction, buying the
scrips in the Indian market and settling it on its own account. The details of
the ultimate investor are not revealed at all in the Indian market or to the
SEBI. The SEBI rule, however, says that P-Notes can be issued only to
regulated entities (in any country). Further transfer of these can also be made
only to other regulated entities. FIIs are not allowed to issue P-Notes to
Indian nationals, persons of Indian origin or overseas corporate bodies (which
are majority owned or controlled by NRIs). This is done to ensure that the P-Note route is not used for money laundering purposes. FIIs are required to
report to the SEBI on a monthly basis if they issue, renew, cancel, or redeem
P-Notes. The SEBI also seeks some quarterly reports about investing in

It is unclear whether re-routing of laundered money is that big a concern to warrant this move? According to Arun Kejriwal, it is! and as per Tushar Poddar of Goldman Sachs (India Views, October 17 2007. Available at, it is not.

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