Who Regulates Participatory Notes? Understanding the Regulatory Framework

Participatory notes, or P-notes, have been a topic of much debate in the financial world lately. These notes are essentially derivative instruments that allow investors to bet on Indian stocks or bonds without actually owning them. The big question is, who regulates these P-notes?

The Securities and Exchange Board of India (SEBI) is the regulatory body responsible for overseeing the Indian securities market, including P-notes. The SEBI was established in 1992 and has been instrumental in developing fair and transparent regulations for the Indian capital market.

However, despite SEBI’s efforts, concerns have been raised about the potential misuse of P-notes. Critics claim that these instruments provide an avenue for money laundering and can be used to channel illicit funds into India. As a result, SEBI has increased its scrutiny of P-note issuers, and there have been calls for even stricter regulations to prevent any misuse of these instruments.

What are Participatory Notes?

Participatory Notes, also known as P-Notes, are financial instruments that are used by foreign investors to invest in Indian stocks without being registered with Indian regulatory authorities. These notes are issued by registered foreign portfolio investors (FPIs) to their clients and are settled outside of India. P-Notes act as a channel for foreign investors who cannot directly invest in Indian stocks due to regulatory restrictions or legal limitations. They provide foreign investors with an easier and faster way to invest in the Indian stock market, without facing the regulatory burden.

  • Participation in Indian equities
  • Issued by registered foreign investors
  • Settled outside of India

P-Notes came into existence in the late 1990s to encourage foreign investment in India and help the Indian economy grow. Currently, P-Notes account for a significant proportion of the total foreign investment in Indian stocks.

History of Participatory Notes

Participatory Notes (PNs) were first introduced in India in 1992 by the Securities and Exchange Board of India (SEBI) to attract foreign investments. The idea was to provide foreign institutional investors (FIIs) with an easy and hassle-free route to invest in the Indian stock market. Initially, PNs were issued only to a limited number of FII sub-accounts to invest in Indian equities. However, over time, the number of FII sub-accounts and the investment allocation via PNs grew significantly.

  • Between 1992 and 2007, PNs recorded an impressive growth of more than 2,000%.
  • During 2007-08, the Indian stock market experienced a boom, and the FII inflow surged. As a result, PNs witnessed their highest outstanding level in May 2008 at INR 4.5 lakh crore.
  • However, at the peak of their popularity, PNs received bad press as they were perceived as instruments for money laundering and round-tripping of black money.

SEBI took note of these concerns and implemented various measures to regulate PNs. One notable action was the introduction of know your client (KYC) guidelines, which made it mandatory for all PNs to comply with the same KYC norms as other categories of foreign investors. In 2014, SEBI completely revamped the PN framework by introducing fresh guidelines and doing away with the issuer-based PN structure. The new framework emphasized the identification of both the end-beneficiary investors as well as the issuance of PNs by entities registered with SEBI.

Currently, SEBI continues to regulate and keep a close watch on the PN segment of the Indian stock market. The regulator reviews the PN data periodically and takes action against any irregularities or violations detected. As of December 2020, the outstanding value of PNs stood at INR 59,946 crore, down from the all-time high of INR 4.5 lakh crore.

Year PNs Outstanding (INR crore) PNs as % of Total FII Assets
2007 4,34,000 52%
2008 3,85,000 45%
2009 1,31,000 11%
2010 32,000 2.3%
2020 59,946 1.5%

While PNs remain a legitimate instrument for foreign investment in India, it is worth noting that their role has diminished significantly in recent years. Despite this, SEBI will continue to regulate them to ensure their proper use and prevent any possible misuse that may harm the Indian financial system.

Global Perception of Participatory Notes

Participatory notes (PNs), also known as offshore derivative instruments (ODIs), have been a topic of debate in the global financial landscape for years. Regulators and market experts have had varying opinions about the use and influence of PNs in the financial markets of the world.

  • India’s Perception: In 2014, India’s regulatory body, Securities and Exchange Board of India (SEBI), tightened the norms for PNs to curb the misuse of these instruments for money laundering and black money. SEBI has been cautious about PNs and their ownership patterns. They are of the view that PNs are often used to bypass regulatory restrictions and launder funds.
  • Europe’s Perception: In Europe, there has been a mixed perception of PNs. The French market regulator, Autorité des marchés financiers (AMF), has expressed concerns about the lack of transparency and ownership of PNs. However, the UK’s Financial Conduct Authority (FCA) and Germany’s BaFin have been neutral about these instruments, with a focus on ensuring a level playing field for all market participants.
  • USA’s Perception: In the USA, PNs are largely viewed as a non-issue, with the Securities and Exchange Commission (SEC) not expressing any major concerns about their use. However, there have been instances of hedge funds using PNs to circumvent regulations in the past, leading to questions about the efficacy of the regulatory framework.

Overall, there is a global perception that PNs are instruments that are often used for dubious purposes. The lack of transparency and clarity around their ownership patterns makes it difficult to regulate their use effectively. It is clear that there is a need for regulators worldwide to collaborate and create a more coherent framework for PNs

Here’s a table summarizing the regulation and perception of PNs in different parts of the world:

Region Regulatory Body Perception
India SEBI PNs often used for money laundering and illegal funds
Europe AMF, FCA, BaFin Mixed views, concerns around lack of transparency in ownership
USA SEC Non-issue, but instances of misuse in the past

It is essential that the regulation of PNs is done correctly and transparently, as this will have a significant impact on the financial markets of the world in the years to come.

Why are Participatory Notes Controversial?

Participatory Notes (PNs), also known as offshore derivative instruments, are financial instruments used by foreign investors to invest in Indian equities without registering with the Securities and Exchange Board of India (SEBI). While some see PNs as a convenient way for foreign investors to invest in Indian markets, others view them as a means of money laundering and a threat to India’s national security. Here are some reasons why PNs have been a topic of controversy:

  • Opacity: PNs allow foreign investors to remain anonymous, making it challenging for regulators to monitor and regulate the flow of money into Indian markets. This opacity gives rise to concerns about money laundering and the potential financing of terrorist activities.
  • Regulatory Framework: PNs are not regulated by SEBI but by the banks that issue them. This lack of regulatory oversight leaves room for unethical practices and the misuse of funds.
  • Tax Evasion: PNs have been accused of being a means of evading taxes, as foreign investors are not required to pay taxes on capital gains from investments made through PNs. This has led to concerns about the loss of revenue for the Indian government.

Despite the controversy surrounding PNs, many foreign investors continue to use them as a means of investing in Indian markets. As a result, the government and SEBI have taken steps to regulate PNs and ensure greater transparency in the investment process.

In 2016, SEBI introduced stricter regulations for PNs, which included requiring issuers to report any suspicious transactions, mandating a minimum investment amount, and limiting the use of PNs in the derivatives market. These regulatory measures were aimed at curbing any unethical practices and promoting greater transparency in the investment process.

Pros Cons
Provides foreign investors with an easy and efficient way to invest in Indian markets Allows investors to remain anonymous, raising concerns about money laundering and the financing of terrorism
Can attract more foreign investment, leading to greater economic growth Not regulated by SEBI, which can lead to unethical practices and the misuse of funds
Can provide a hedge against currency risk for investors Accused of being a means of tax evasion, leading to concerns about the loss of revenue for the Indian government

The debate around PNs is ongoing, with proponents arguing they are necessary for foreign investment in Indian markets and opponents concerned about the lack of transparency and accountability in the investment process. As India’s economy continues to grow and attract more foreign investment, it remains to be seen how PNs will be regulated in the future.

Regulators of Participatory Notes

Participatory Notes, also known as P-Notes or Offshore Derivative Instruments (ODIs), have been subject to regulatory scrutiny and oversight in India. The regulatory framework for P-Notes is governed by the following entities:

  • Securities and Exchange Board of India (SEBI) – SEBI is the primary regulatory body responsible for overseeing P-Notes. It has put in place several guidelines and regulations that P-Notes issuers and investors must adhere to. SEBI also requires P-Note issuers to be registered as foreign portfolio investors (FPIs) and follow strict disclosure norms.
  • Reserve Bank of India (RBI) – The RBI plays a vital role in regulating P-Notes by monitoring the flow of foreign funds in and out of India. It ensures that P-Notes are not being used for money laundering, illegal activities, or tax evasion. RBI also regulates the foreign exchange market and imposes restrictions on the repatriation of funds invested in P-Notes.
  • Department of Economic Affairs (DEA) – The DEA is responsible for monitoring the overall foreign investment policy in India. It sets the rules for foreign investors, including those investing through P-Notes.
  • Income Tax Department – The Income Tax Department scrutinizes the income earned by P-Note investors and issuers, and ensures that they comply with all relevant tax laws. It also takes action against those who try to evade taxes using P-Notes.
  • Financial Intelligence Unit – The Financial Intelligence Unit monitors money laundering activities and any suspicious transactions involving P-Notes. It works closely with SEBI and the Income Tax Department to investigate any cases of financial irregularities.


India has a robust regulatory framework in place for P-Notes to ensure transparency and prevent any misuse of these instruments. P-Notes are subject to multiple layers of regulation and oversight by various bodies, including SEBI, RBI, DEA, Income Tax Department, and Financial Intelligence Unit. This ensures that P-Notes are being used only for legitimate purposes and not for illicit activities.

Regulatory Body Responsibilities
SEBI Primary regulatory body responsible for overseeing P-Notes, requires registration as FPIs and strict disclosure norms
RBI Monitors foreign fund flow, prevents money laundering and illegal activities, regulates foreign exchange market
DEA Responsible for monitoring overall foreign investment policy, sets rules for foreign investors
Income Tax Department Scrutinizes income earned by P-Note investors and issuers, ensures tax compliance, takes action against tax evasion
Financial Intelligence Unit Monitors money laundering activities and suspicious transactions, investigates financial irregularities

With such stringent regulatory oversight in place, investors can confidently use P-Notes to invest in Indian markets, and issuers can offer these instruments to offshore clients without fear of any regulatory backlash.

How are Participatory Notes Registered?

Participatory notes (PNs) must be registered through the Securities and Exchange Board of India (SEBI) under the SEBI (Foreign Portfolio Investor) Regulations, 2019. Additionally, PN issuers need to be registered as Foreign Portfolio Investors (FPIs) with SEBI.

  • Registration Process: FPIs must apply for registration through a designated depository participant (DDP) and submit the necessary documentation to SEBI. The documents include a copy of the certificate of incorporation, memorandum and articles of association, board resolution, KYC documents, and more.
  • Approval Process: SEBI reviews the application and makes a decision within 10-15 business days. If approved, the FPI will receive a certificate of registration and will be eligible to issue PNs.
  • Renewal Process: FPI registration and PN issuance approvals are valid for three years and must be renewed before expiry.

Once an FPI has received registration with SEBI, they can issue PNs to investors outside of India who wish to invest in Indian securities. The FPI provides the PN holder with the rights to receive dividends or capital gains from the underlying securities without owning them directly.

SEBI has implemented regulations to ensure that PNs are issued and traded in compliance with Indian securities laws. Any violations can result in the revocation of registration and fines for the issuer and the investor.

Participant Regulations
FPIs SEBI (Foreign Portfolio Investor) Regulations, 2019
PN Issuers SEBI Circular No. IMD/FPI&C/146/2015 and SEBI Circular No. SEBI/HO/IMD/DF3/CIR/P/2019/115
PN Holders SEBI (Foreign Portfolio Investor) Regulations, 2019

Overall, SEBI provides oversight and regulation over the registration, issuance, and trading of Participatory Notes in India to ensure that investors are protected and that the Indian securities market operates in a fair and transparent manner.

Future of Participatory Notes

Participatory notes (PNs) have been a long-standing issue in the Indian financial market. The Securities and Exchange Board of India (SEBI) has taken several measures to regulate them over the years. However, the future of PNs still remains uncertain. Here are some of the developments that are likely to shape the future of PNs:

  • Stricter regulations: In recent years, SEBI has introduced various regulations to strengthen the monitoring of PNs. SEBI has increased KYC (know your client) requirements, capped the amount of PNs issued, and made it mandatory for issuers to report regularly to SEBI. It is expected that SEBI will continue to tighten the regulations to prevent misuse of PNs in the future.
  • Shift towards onshore investments: Several foreign investors have started moving towards onshore investments in India. This is primarily due to the gradual removal of capital gains tax on equity investments for foreign portfolio investors (FPIs). Onshore investments provide greater transparency and are subject to tighter regulations, making them a more attractive option than PNs.
  • Increased investor awareness: With the rise of social media and financial blogs, investors are becoming more aware of the risks associated with PNs. This has led to a decline in PN investments in recent years. It is likely that this trend will continue as investors become more informed and cautious.

Despite the efforts to regulate PNs, there are still concerns over their use in money laundering and tax evasion. Therefore, it is necessary to address these issues to ensure a transparent and efficient financial market in India.

Below is a table summarizing some of the recent regulations introduced by SEBI to regulate PNs:

Regulation Description
KYC requirements SEBI has increased KYC requirements for PN investors to ensure that the identities of investors are verified and monitored.
PN issuances SEBI has capped the amount of PNs issued to ensure that they are not used for money laundering or tax evasion.
Reporting requirements PN issuers are required to report regularly to SEBI to ensure that the use of PNs can be monitored and analyzed.

In conclusion, the future of PNs in India remains uncertain. It is likely that SEBI will continue to tighten regulations to ensure that they are not misused. However, the shift towards onshore investments and increased investor awareness may reduce the use of PNs in the future. Only time will tell what the fate of PNs will be in India.

FAQs: Who Regulates Participatory Notes?

1. What are participatory notes?

Participatory notes are financial instruments used to invest in Indian securities without having to go through the regulatory process of registering with the Securities and Exchange Board of India (SEBI).

2. Who can issue participatory notes?

Participatory notes can only be issued by registered foreign institutional investors (FIIs) and sub-accounts.

3. Who regulates participatory notes in India?

Participatory notes are regulated by the SEBI, which requires FIIs and sub-accounts issuing such notes to adhere to its guidelines on the issuance and use of participatory notes.

4. What guidelines does SEBI have for participatory notes?

SEBI guidelines require the FIIs and sub-accounts issuing participatory notes to maintain records of the beneficial owners of such notes, as well as conduct proper due diligence on such owners and ensure they are not involved in any illegal activities.

5. Are participatory notes subject to any tax regulations in India?

Yes, the Indian government has introduced a tax on participatory notes issued by FIIs as part of its efforts to curb the flow of black money and improve transparency in the country’s financial system.

6. Is there any controversy surrounding participatory notes in India?

Yes, there has been controversy surrounding participatory notes in India, with critics arguing that they can be used by investors to launder money and evade taxes.

7. What is SEBI doing to address concerns about participatory notes?

SEBI has introduced several measures to address concerns about participatory notes, including imposing stricter due diligence requirements on the issuers of such notes and requiring them to maintain records of the beneficial owners of such notes.

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