Sebi's new P-note rule can curb black money coming in through FII inflows

With FII inflows through the participatory note (P-note) route hitting an 80-month high of Rs 2.65 lakh crore in October, Sebi has tightened rules relating to issuance of P-notes, also known as offshore derivative instruments. It is widely suspected P-notes are a conduit for bringing black money parked abroad, back into India.

P-notes are offshore derivative instruments issued by Sebi-registered FIIs to overseas investors who do want to register with Sebi for reasons legitimate or devious. The registered FII buys shares/derivatives on behalf of the unregistered players, and issues P-notes (a receipt of sorts) since the ownership of those shares/derivatives cannot be transferred to the unregistered players.

Under the new rules, a Sebi-registered foreign portfolio investor (FPI) can now issue P-notes only to those entities based in countries where the securities regulator and central bank are members of globally recognized bodies like IOSCO and Bank for International Settlements (BIS).

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Also, P-notes cannot be issued to entities residing in a country not compliant with Anti-Money Laundering and Combating Financial Terrorism regulations.

Entities with opaque structures too will be ineligible for subscribing to P-notes. Sebi regulation defines “opaque structure” as one in which the details of the ultimate beneficial owners are not accessible or where the beneficial owners are ring fenced from each other or where the beneficial owners are ring fenced with regard to enforcement.

Protected cell company (PCC) or multi class structure is one example of an opaque structure. It is somewhat similar to the structure of a mutual fund offering different schemes depending on the risk profile of the investors. A PCC will have different pools of investments, each managed by a different fund manager.

Corporates looking to bring back their illegal money stashed abroad usually subscribe to one cell of a PCC, and direct the fund manager on the trades to be done.

Under the new rules, two or more P-note subscribers having common Beneficial Owner (BO) shall be considered together as a single P-note subscriber. No FII is allowed to hold more than a 10 percent in a listed company. In cases where a Sebi-registered FII holds positions through P-notes, the investment cap will be applicable on the aggregate of the positions held as an FII as well as a P-note subscriber.