Participatory notes: To Ban or not to ban

Participatory notes (PN) are simple instruments used by foreign investors who are not registered with SEBI but want to take exposure in Indian securities. Participatory notes are typically issued by brokerages houses in India or their associates. FIIs who don’t want to register with SEBI but want to take exposure in Indian securities also use PNs. Brokers buy or sell securities on behalf of their clients on their proprietary account and issue PNs in favour of the interested foreign investors. The PN issuer also repatriates the dividends and capital gains back to these investors. So the PN issuers act like an exchange; they execute the trades and use their own accounts to settle the trades. They keep the investor’s name anonymous. This is the primary issue.

In the last 3 years over $ 20 Billion was invested in India by FIIs. Over 20% of this amount was through the PN route. That’s a lot of money through unknown sources. SEBI is of the view that a good chunk of this amount is hedge fund money, Indian money routed back into India through various illegal means and unknown wealthy private investors. This makes SEBI and RBI very uncomfortable as they are unable to either regulate them or find out about them.

The flight of capital is an important factor, which makes the regulators jittery. The East Asian Crises is a good example of this. In the late 1990`s large amount of capital was withdrawn from the Asian economies like Malaysia, Thailand, etc by foreign investors; hurting these economies. SEBI and RBI do not wish for that to be repeated in India.

While the concerns of SEBI and RBI are fair and genuine, banning PNs completely is not the way forward. PNs are an easy way of investing and huge amount of money has already been invested through this route. Banning PNs will likely lead to flight of capital leading to a big fall in stock market and a quick depreciation of the rupee as well. It will also erode the confidence of the investors in general and small Indian investors in particular.

Then how should this problem be tackled?

SEBI and RBI must make it easy for international investors (be it Institutions or Individuals) to register and invest directly in India. This will make their task more simpler.