Participatory Notes

What are Participatory Notes?

Foreign investment in India can be classified in broadly two ways Foreign Direct Investment
(FDI) and Foreign Institutional Investments (FII). Under both these scenarios, foreign money
enters Indian markets and fuels growth of industries and capital markets. However, with growing
regulations, its not that simple for this money to enter the markets.

There are detailed guidelines laid down for seeking approvals and documentation for FDI.
Further, there are also several restrictions laid down on the exit of this money. On the other
hand, FII is mainly characterized as Portfolio Investment i.e. money entering the country for
short-term investment into the markets and quick money. Due to its short-term characteristics,
the regulators have laid far fewer regulations on this money vis--vis FDI. But, the fact remains
that foreign money cannot enter into Indian markets without regulatory approvals.

So, the question that arises is what happens to all those overseas investors, who wish to
invest in the Indian stock markets but without getting into the regulatory approvals & allied
hassles? Well, the answer is Participatory Notes.

Participatory Notes are issued by registered Foreign Institutional Investors (FIIs) to all those
overseas investors who wish to invest in the Indian stock markets and at the same time do not
want to disclose their identities or get registered with SEBI. Participatory notes are more
commonly known as P-Notes. Any income arising from the underlying notes is passed onto the
ultimate investors since these notes can be characterized as derivative instruments.

Functioning and advantages of Participatory Notes:

FIIs operating in India, issue P-notes to investors and collect funds outside India which are
never transmitted to India. However the FII uses their proprietary account to buy stocks for
these investors.

Trading through participatory notes is easy because

1) Participatory notes are easily transferable by endorsement and delivery.

2) It allows the overseas investors to take advantage of the tax laws of certain preferred
countries.

3) The anonymity of the investor is maintained, which allows large hedge funds to carry out
their operations smoothly without disclosing their identity.

Criticism regarding P-Notes:

Indian regulators are not very happy about Participatory Notes because they have no way to
know who owns the underlying securities.
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Participatory Notes

Regulators fear that hedge funds acting through Participatory Notes will cause economic
volatility in India's exchanges and has the potential to pave the way for black money to enter
into the system.


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