18 October, 2007

What are P-Notes?

18 Oct, 2007 The Economic Times

Q: What are participatory notes?

A: Participatory notes (PNs) are instruments used by foreign funds, not registered in India, for trading in the domestic market. They are a derivative instrument issued against an underlying security that permits the holder, some of whom may not be eligible to trade in Indian stock markets, to get a share in the income from the underlying security.

The investors, who buy PNs, deposit funds in US or European operations of the FII, which also operates in India. FII uses its proprietary account to buys stocks in India. A government report has said that FII or the broker acts like an exchange since it executes the trade and uses its internal accounts to settle this. Other such instruments include equity-linked notes, capped return note, participatory return notes and investment notes.

Q: Why investors use PNs?

A: While one reason for using PNs is to keep the investor’s name anonymous, some investors have used the instrument to save on transaction costs, record keeping overheads and regulatory compliance overseas. A report said investors often find it expensive to establish broker and custodian bank relationships, deal in foreign exchange, pay taxes and/or filing, obtain or maintain an investment identity or regulatory approval in certain markets, where their total exposure is not going to be very large.

Such investors look for derivative solution to gain exposure in individual, or a basket of, stocks in the relevant market. Sometimes, investors enter the Indian markets in a small way using PNs, and when their positions become larger, they find it advantageous to shift over to a full-fledged FII structure.

Q: What is the problem with the instrument?

A: RBI, which had sought a ban on PNs, believes that it is tough to establish the beneficial ownership or the identity of ultimate investors. It fears that FIIs, which have to comply with the know-your customer norms, know the identity of the investor to whom the note was issued. But it is possible for the investor to sell the PN to another player resulting in multi-layering. Tax officials fear PNs are becoming a favourite with many Indian money launderers who use it to first ship funds out of the country, through hawala, and then get it back using PNs.

Q: What is the extent to which PNs are used?

A: Over the years, the use of PNs has increased from 17 FIIs issuing it in 2005 to over two dozen funds now. Merrill Lynch, Morgan Stanley, Credit Lyonnais, Citigroup and Goldman Sachs are the biggest issuers. The total value of underlying investments in equity represented by the PNs was Rs 67,185 crore or 25.7% of FIIs’ net investment in equities in June, 2005. By August 2007, the notional value of PNs was Rs 3.53 lakh crore — about 51.4% of all assets under all FIIs present in India.

http://economictimes.indiatimes.com/Analysis/What_are_P-Notes/articleshow/2468917.cms


With Thanks from The Economic Times

deepakmiglani@hotmail.com


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