P-Note: New rules of the game decoded

CNBC-TV18’s Latha Venkatesh decodes the impact of the tighter P-Note norms on the market.

One has be very clear about the Indo–Mauritius rules and the Participatory notes (P-note) because the Mauritian treaty was for all investors coming out of Mauritius and the fact that they have to pay capital gains. The identity through which they invested was not really a question in the Mauritian treaty. Participatory notes, or not wanting to directly invest in India but invest through a derivative instrument which will rise and fall depending on the underlying share is altogether another kettle of fish, which the SEBI has been trying to regulate for a long time. Already the history to this rule is the SEBI had two years ago told brokerages, who sell P-notes that you have to categorise the foreign investors - not just the P-note guys but the registered foreign portfolio investment (FPIs) into three buckets. One was sovereign wealth funds, for which you didn't have to know your customer (KYC). The second category are those funds which are widely held and widely regulated in their own countries – The Blackrock’s, the Fidelities. The last one was where one was not very sure of the beneficial owner and where the KYC was insisted on; even for FPIs. So, what they have said on Thursday is an extension of the same thing. Many of these rules already exist.

RULES

First, the one who is selling the offshore derivative instruments (ODI) --  Morgan Stanley or the Crédit Lyonnais whoever -- that guy will be subject to Indian KYC rules. Until now he was subject to foreign rules, the destination country or our country. Now they are saying that the issuer should be subject to Indian rules and nobody worries about that. The worry was for the guy who is buying the participatory notes. Suppose, you say, find the KYC of every guy who is investing through exchange traded funds (ETF). Then there would be a problem. However, all that SEBI has said is that if the P-note is bought by a company and that company is owned more than 25 percent by one individual then that individual’s KYC should be known or the P-note is bought by a partnership (say five-six people) and they own more than 15 percent, then that persons’ KYC - address, bank statements everything should be known. That is fair; most of the market participants or even guys who write P-notes and sell them abroad believe that that is very fair. If it is widely held and if no one person owns more than 1 percent of the P-note holding company, then there is no problem. Usually ETFs hold it that way.