India: P-Notes: An Effective Instrument With Twists And Turns


Participatory Notes, ("PN") commonly known as P-Notes are instruments used for making investments in the stock markets. In Indian context, PNs are such instruments which are issued by registered Foreign Institutional Investors ("FII") or Foreign Portfolio Investors ("FPI") to overseas investors, who wish to invest in the Indian stock markets without registering themselves with the Securities and Exchange Board of India ("SEBI").

Such PNs are also called Offshore Derivative Instruments ("ODI") as they are used outside India for making investments in shares listed in the Indian stock market. P-Notes are as good as contract notes which are transferrable by endorsement and delivery. Therefore P-notes are easy to operate as compare to other instruments which are being used by foreign investors for making investment in Indian market. Such P-notes are free from any jurisdiction or control of SEBI, therefore, such P-Notes are being traded outside India freely.

P-Notes are not required to be registered as registration of FIIs with SEBI is mandatory for trading such P-Notes. This is the reason P-Notes are very popular instrument for investment in India as it permits the identity of the investor to be kept unidentified and anonymous. Thus, trading of such P-Notes freely makes it very difficult to find the original owner of these P-notes as these are impenetrable and the identity of the owner is known only to the FII.


Trading in P-Notes is believed to be a murky route for investment in India as such course provides scope for round-tripping of money i.e. the practice of money squirrel away overseas by Indians returning home through tax havens in the form of foreign capital and promoting money laundering.

Since introduced in the Indian market, P-notes have been recognized contentious instruments and it seems very sentimental issue as whenever the Government or SEBI tries to regulate them, the market starts falling thwart the government to take the inconsiderate move. It is also anticipated that through this course of P-Notes the promoters of an Indian company may re-route their funds in their own companies. Therefore, such promoters or existing shareholders may defy the norms of insider trading as formulated by the SEBI for all listed companies in India.

SEBI, the market regulator for the securities market in India, in the year 1992 has permitted FIIs to register and participate in the Indian stock market. However, since the time they were introduced in Indian securities market, the Government has been seeking to regulate them. The Reserve Bank of India ("RBI") has been against the idea of P-Notes and also raised its concern from time to time on the hidden identities of investors and multi-layering of investment. Therefore, it has been considered that P-notes may be used as money laundering instrument.

However, during the initial period of its implementation in the Indian market, FIIs generated a lot of business from monies routed through P-notes. With these amount of investments in the form of P-notes the security market was stimulated during the early period of liberalization in India.


It has been observed that SEBI and RBI were not happy with the salient character of the P-Notes being unattainable to know the holder of the underlying securities. Due to this character of P-Notes the funds may be hedged to cause volatility in the Indian securities markets.

With this viewpoint, the SEBI, on October 16, 2007, proposed curbs on P-Notes which accounted for roughly 50% of FII investment at that time. However the proposals of SEBI were not clear and this led to a hasty crash down of the market when it was opened on the following day i.e. October 17, 2007. Within a minute of opening trade, the Sensex crashed by 1744 points approximately 9% of its value. This was believed to the biggest intra-day fall in Indian stock-markets in absolute terms. This led to automatic suspension of trade nearly for 1 hour. The then Finance Minister Mr. P. Chidambaram issued clarifications, in the meantime, that the government was not against FIIs and was not immediately banning P-Notes. Mr. Chidambaram clarified that that SEBI's move to impose some restrictions on investments through the P-Notes route was aimed at moderating capital inflows and were in the interest of investors across all categories.

This was, however not the end of the volatility. The next day again i.e. October 18, 2007, the Sensex tumbled by 717.43 points (3.83%) its second biggest fall. The slide continued the next day when the Sensex fell 438.41 points to settle at 17559.98 at the end of the week, after touching the lowest level of that week at 17226.18 during the day.

Thereafter, the then SEBI chief, Mr. M. Damodaran on October 22, 2007 announced that funds investing through P-Notes were most welcome to register as FIIs, whose registration process would be made faster and more streamlined. The markets welcomed the clarifications with an 879 point gain, its biggest singleday surge on October 23, 2007, indicating the end of the P-Notes crisis.

The above stated remembrance of the fall of stock market by 1744 point on October 17, 2007 and subsequent volatilities on following days when SEBI first proposed curbs on P-notes is enough to spread fear in the mind of investors.

Since then, SEBI has adopted a cautious approach towards tightening of regulations relating to P-Notes. The norms have been tightened considerably for P-Notes over the years to put in place strong checks and balances to avoid misuse of P-Notes.


As observed from the past, whenever there was an attempt to curb flows of P-notes by tightening the norms, the Indian securities market has fallen. As seen in the past and noted herein above concentrated effort was attempted in 2007 when a phasing out of P-Notes was sought and consequent crash of the market around 10% within minutes of market opening for the first time after the announcement.

Accordingly, with due care and deliberation, SEBI announced in the year 2014, that P-Note can be issued only to investors coming from jurisdictions that have anti-terror funding norms and anti money laundering norms just to keep a limit on the flow of money through P-Notes and to check on the flow of black money in India.

The Hon'ble Supreme Court has appointed Special Investigation Team (SIT) on black money in the year 2014 which has also recommended some checks on P-Notes upon which the SEBI has started implementing the said recommendations. The SIT report in July 2015 made some critical observations on P-Notes and suggested increased regulation of fund flows through this route.

The SIT strongly suggested that the SEBI should put in place more stringent regulations to help identify individuals holding P-Notes or other ODIs, and take other steps required to curtail black money and tax evasion through the stock market route.

As per recommendations of the SIT, SEBI exposed new norms for P-Notes which includes that all details of the 'beneficial owner' must be disclosed in accordance with the KYC norms. Thus, in case there is transfer of P-Notes, SEBI can be able to identify the 'final beneficial owner'. In this regard, SEBI has mandated all P-Notes issuers to capture the details of all intermediate transfers during the month and report the same. Thus, the transfer of P-Notes will be restricted and allowed only after prior consent of the issuer. It means that for every downstream transfer of a P-Note, prior consent of the issuer would be needed. In addition to this, transfer of a P-Note will be allowed only to a pre-approved list of subscribers.

Further, now P-Notes Issuers will need to verify entities that hold more than the predefined thresholds. Such predefined thresholds for companies would be 25% of the total P-Note size and for proprietorship and partnership firms and trusts, the limit of such predefined thresholds has been set at 15%. Accordingly, the P-Notes issuer will now need to report who controls the management and operations of a P-Note subscriber. The above said proposed changes came in the wake of the concerns raised by the Supreme Court-appointed Special Investigation Team (SIT) on black money on the identification of beneficial owners and on the transferability of P-Notes.

SEBI has also made it mandatory that P-Note issuers would have to follow the Indian know-your client (KYC) and anti- money laundering norms instead of the norms prevalent in the jurisdiction of the end beneficial owner or of the P-Note issuer.


The SEBI had permitted the issuance of P-Notes in 1992 to encourage foreign investments in wake of the crisis of 'balance of payments' during the year 1991. Since then, such P-Notes has contributed around 11.5% of the total assets held by Foreign Portfolio Investors in India. It is important to note that majority of foreign portfolio investments in India are made in the form of P-Notes or ODIs. Therefore, for the fortification of foreign investment in India P-Notes are very important tool.

However, at the same time it is not free from hitches. The main and serious concern in the P-Notes, as discussed herein above as well, that it can encourage black money and money laundering activities including promoting terror funding as the identity of persons investing in the P-Notes remain unidentified to the regulators. Due to this drawback the Government attempted from time to time to curb the norms relating to P-Notes. However, the Indian securities market is more sensitive with respect to this instrument and it reacted badly whenever there is any proposal to curtail the P-Notes as seen in the past as well. Recently, SEBI has introduced a number of compliance to be made to the FII and P-Notes issuers with the objective of keeping check on the flow of black money. Such norms or compliance may reduce the interest of investors in the P-Notes and consequently this may result in making the instrument irrelevant in long run. Therefore, the ideas to curb P-Notes more strictly would be harmful for the Indian securities market. Any rigid regulation or compliance may create a sense of insecurity in the mind of foreign investors which could lead to the collapse of the security market. Hence, it may be considered to regulate wisely such P-Notes and simultaneously, if it is proposed to phase out this instrument from the market, other alternative lucrative instruments should be promoted by the regulators to maintain the foreign investment in India unaffected.

Source: Recommendations of SIT on Black Money as contained in the Third SIT Report, Press Information Bureau, Ministry of Finance, Government of India, July 24th, 2015

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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