P- Notes's

The Nifty tanked 1.88% on the first trading day of the last week of July 2015. The sharp plunge in the benchmark indices was on account of two reasons – one in the global context and the other in the domestic context. China’s equity market tanked 8.48% on 27^th July 2015, which led to global equity markets also feeling the pinch as the World’s second largest economy is set to grow at a slower pace than expected. The P-Notes issue has once again come into limelight similar to the situation that was seen in 2007. 

Participatory Notes commonly known as P-Notes are instruments through which foreign individuals, hedge funds and others invest in India’s stock markets without being registered with market regulator Securities and Exchange Board of India (SEBI). P-Notes are popular with foreign investors because they are able to save time and the costs associated with direct registration with Indian authorities. In 2007, a crackdown on P-Notes had led to a 10% fall in the Sensex within minutes of the market opening. Trading had to be halted and then finance minister P Chidambaram had to make statements to calm the markets.

Investments through participatory notes in India’s capital market were about USD 43 billion at the end of June 2015. This amounts to 21% of the total foreign institutional investment (FII) in Indian markets. Investment through P-Notes has been steadily decreasing over the years. Till a few years ago, P-Notes used to account for more than 50% of total FII investments, but their share has fallen as SEBI has tightened disclosure norms and other related regulations.

The Supreme Court appointed special investigation (SIT’s) recommendation of stricter norms for P-notes would be viewed negatively by the market. SIT suggested that SEBI put in place regulations to help identify individuals holding P-notes or off shore derivative instruments (ODI) and take appropriate steps to curb black money and tax evasion using the stock exchange.

Based on data from SEBI, SIT report said a major chunk of the offshore derivate instruments that invested in India were coming from Cayman Islands around 31%, which translates into INR 85,000 crores. In 2010 Cayam island has a population of 59,000 going by the 2013 census which suggest that with this kind of population and size most funds flowing from Cayam islands are not originated from there but the jurisdiction is just used as a conduit to channelize the funds into the stock market. By which it definitely cannot be concluded that all the funds that are coming from offshore jurisdictions would result in tax evasion. Most of the funds that are channelized via an offshore jurisdiction like Cayam are structured in a way to take most use of the tax treaties between nations resulting in efficient tax planning and better net return on capital. 

Investors need not panic as the P-Notes issue is a temporary obstacle and the long term growth story remains intact for the Indian economy. Any correction in the benchmark indices would present an opportunity to buy from a long term perspective. The Finance Minister has given a clarification that the Government would not take any drastic steps to demotivate FIIs and spoil the investment climate in the economy.

With growth slowing around the world along with China, the long term story of India looks intact with favorable demographics, stable government and growing consumption the long term story of India looks intact and the events like P-note saga could impact the markets in the short term but on a long term horizon the markets would continue to grow outperform most markets around the world.

_ Farzan Ghadially