[Econ] P - Notes

Economics

P – Notes

·        Participatory Notes (P-Notes) are instruments issued by registered FIIs (Foreign Institutional Investors) to overseas investors, who wish to invest in the Indian stock markets without registering themselves with SEBI.

·        Investing through P-Notes is very simple and hence very popular amongst FIIs

·        P-Notes mainly used in stock markets

·        They are not used within the country

·        They are used outside India for making investments in shares listed in the Indian stock market. Hence called as “offshore derivative instruments”

What is P-Notes /Participatory Notes?

·        Tom Cruz wants to get maximum return on the investment in quickest possible time.

·        For this, Tom will have to find risky securities (shares/bonds) in third world countries, then invest money from one country to another quickly, depending on how share market moves.

·        In India, no one can invest in share market without getting PAN card + DEMAT account first. Other nations too have similar mechanism.

·        But if Tom tries to get PAN card and DEMAT account in each third world country, then his profit will decline- given the cost of running branch office, staff salary, DEMAT fees etc. in each country.

·        So, to take a shortcut, Tom will contact some ‘middleman’ who is already registered as an FII, has PAN card & DEMAT in India. e.g. HSBC.

·        Tom gives money to HSBC, with instruction “buy A, B and C shares/bonds in X, Y and Z quantity.”

·        HSBC buys Indian shares. They’ll be stored in DEMAT account of HSBC, and won’t be given to Tom.

·        But HSBC then gives a receipt to Tom listing the shares/bonds purchased on his behalf and stored in HSBC’s DEMAT account.

·        This receipt is called Participatory Note.

·        Technically, it is called “offshore derivative instrument”. Observe the words

OFFSHORE (Because foreigner owning something in India, without coming to India or opening office in India)

DERIVATIVE (Because this receipt doesn’t have value of its own; It “derives” its value from the market value of shares/bonds held by HSBC. Today it may be worth $1000, tomorrow $12000 depending on how the prices of Indian securities move)

INSTRUMENT (Self-explanatory- this is one type of financial instrument to invest abroad)

·        1992: SEBI had permitted P-notes, to boost foreign investment in India, after BoP crisis of 1991.

·        P-note owner doesn’t own the shares. (because they’re in the DEMAT account of that intermediary FII)

·        P-Note owner doesn’t have voting rights in the shareholder meetings

Why Ban Participatory Notes (P-notes)?

·        As of March 2014, Foreigners invested ~Rs. 2 lakh crore in India via P-notes. (this is 13% of the total FII money coming in India)

·        As such the FII has to disclose P-note owner data to SEBI on quarterly basis (every 3 months). But often, within 3 months the P-notes would have changed many hands (e.g Tom to Jerry to Micky to Goofy).

·        Thus P-note investments are Anonymous. Hard to trace the owner. Can be used for money laundering and terror financing.

·        Hot Money: can leave Indian market very soon based on just one phone call from Tom Cruz to HSBC. Hot money creates heavy rise or fall in share market, so even genuine investors’ money is lost.

·        e.g. Tom continuously buys Infosys shares, they goup to Rs.3000 per share. So, you (indian) also buy, thinking “Infosys will go even higher to 3500, and I’ll make profit”.

·        But suddenly tom sells everything, to invest in China for better return.

·        Now Infosys sells not even for 2000. Then you (Indian investor) lost 1000.

P-Notes, Money laundering & Terror Financing:

·        Finance Ministry Whitepaper: Indians first send their money to Cayman Islands, British Virgin Islands, Switzerland, or Luxembourg via Hawala operators. Then, their agents convert rupees to dollars, re-invest it in Indian market through P-notes. It is possible to hide the identity of the ultimate beneficiaries, because of these multiple layers. Thus, P-notes are used in money laundering.

·        Ex-National security Advisor MK Narayanan: Terrorists are using P-notes to invest in Indian stock market, and using the same profits to finance terror operations against India. They may use this mechanism to first boost Indian stock exchange, then collapse it by quickly pulling out money from the market. Doubt: how can a poor Pakistan afford creating volatility in Indian market? Ans. Via printing fake Indian currency, converting it to dollars in a tax haven, to buy P-notes via a post office company!

·        RBI’s Tarapore Committee: Recommended Banning P-notes for national security and to stabilize stock exchanges

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