What are P-Notes? P-Notes or Participatory Notes are Overseas Derivative Instruments that have Indian stocks as their underlying assets. They allow foreign investors to buy stocks listed on Indian exchanges without being registered. The instrument gained popularity as FIIs, to avoid the formalities of registering and to remain anonymous, started betting on stocks through this route.

What are govt & regulator’s concerns? The primary reason why P-Notes are worrying is because of the anonymous nature of the instrument as these investors could be beyond the reach of Indian regulators. Further, there is a view that it is being used in money laundering with wealthy Indians, like the promoters of companies, using it to bring back unaccounted funds and to manipulate their stock prices.

What has Sebi done to regulate P-Notes? Sebi has taken a number of steps to tighten rules on P-Notes. In 2007, P-Notes were banned for a while due to a surge in capital flows and excess liquidity. After this, markets crashed immediately, but recovered after the regulator said FIIs could not take any fresh exposure, and their existing investments would have to be wound up in 18 months. But a year later, all restrictions on P-Notes were removed during the financial crisis, only to be tightened again later.

From January 2011, FIIs have had to follow KYC norms and submit details of transactions. In 2014, new rules on foreign portfolio investors (FPIs) made it mandatory for those issuing P-Notes to submit a monthly report disclosing their portfolios. This led to a decline in the number of entities issuing P-Notes. More recently, Sebi mandated that in addition to KYC, the anti-money laundering rules (AML) will also be applicable to P-Note holders. Earlier, a P-Note holder had to adhere to KYC or AML norms of just their home jurisdiction. Sebi also issued norms on transferability of P-Notes between two foreign investors and increased the frequency of reporting by P-Note issuers.

Do regulators wish to ban P-Notes? Sebi is not in favour of banning the instrument as it is used globally in many markets. In a recent interview to ET, Sebi chairman UK Sinha said: “Participatory notes, in Sebi’s and government’s views, are legitimate instruments that are required for normal financial transactions and are prevalent in all the larger markets.” It is nothing unique to India and there are business reasons for having these transactions through PNs. According to Sinha, out of the 9,000 FPIs registered with Sebi, 37 are issuing P-Notes.