MUMBAI: The Securities and Exchange Board of India plans to put in place further restrictions and squeeze the use of participatory notes — an offshore derivatives instrument that allows investors to bet on India without registration.
The regulator, in a consultation paper on Monday, proposed barring issuance of P-Notes and similar instruments against derivatives in the country unless meant for hedging purposes. Sebi also plans to levy a regulatory fee on brokers issuing P-Notes that could encourage foreigners to register with it.
By using P-Notes, a foreign portfolio investor can bet on equity, debt or equity derivatives in India. Brokers issue P-Notes to foreign portfolio investors, who then become indirect holders of the underlying shares, bonds or derivatives.
Sebi will give time till December 31, 2020, to wind up all P-Notes issued against derivatives that are not for hedging purposes.
“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,” said the paper released for public comments. 
As of April 2017, overseas derivative instruments (ODIs) such as PNotes issued against derivatives were worth Rs 40,165 crore, which is 24% of the total notional value of outstanding ODIs.
Experts said the proposal may not rattle the market.
“Sebi’s circular is unlikely to cause any panic as the volume of trades via P-Notes in derivatives is very less compared with their overall position in the market,” said Bhavin Shah, partner and leader (financial services tax), PwC.
Others said market participants were prepared for a squeeze on PNotes.
“Large banks and funds have been unwinding derivative positions for some time now as it is well understood that P-Notes are being discouraged. Also, the current Sebi paper is structured in a manner that it ensures there is no panic in markets,” said Saurabh Mukherjea, CEO, institutional equities, Ambit Capital.
The clampdown on P-Notes follows concerns that the instrument is being used for round-tripping, which involves bringing back illegal money. Last month, the markets regulator had barred Indians and non-resident Indians from using P-Notes to make investments here.
Sebi has also proposed a fee on entities issuing ODIs, including P-Notes. The regulator plans to levy a fee of $ 1,000 on each ODI-issuing entity for every buyer coming through it from April 1, 2017, for three years.
“We understand from the monthly ODI data reported by the ODI issuers that quite a few ODI subscribers invest through multiple issuers. It will discourage the ODI subscribers from taking ODI route and encourage them to directly take registration as an FPI,” the regulator said in the paper.
The proposal to implement a regulatory fee will require changes to the Sebi regulations.
The regulator said the fee will help it maintain systems to keep track of P-Note issuances.
