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Q. SEBI on participatory notes: Comment on SEBI’s move to tighten the norms for participatory notes.
Jun 07, 2017 Related to : GS Paper-3

Ans :

Introduction-

Recently the Security Exchange Board of India (SEBI) has proposed to tighten the rules for participatory notes (P-notes) to enhance transparency with regard to the identity of those investing in Indian stocks. The SEBI’s move to proposal of tightening makes sense, as P-notes have various issues associated with them like money laundering. 

P-notes-

P-notes are financial instruments used by investors or hedge funds that are not registered with the SEBI to invest in Indian securities. Any dividends or capital gains collected from the underlying securities go back to the investors. In P-notes identity of the investors are not disclosed. 

Analysis-

  • In India, regulators and many observers are against participatory notes because they fear that hedge funds acting through participatory notes will cause economic volatility in India's exchanges.
  • There are growing concerns about money laundering, that organised gangs are using P-notes to launder the money for unlawful activities. 
  • In this background new rules include levying a regulatory fee on issuers of P-notes offshore derivative instruments (ODIs) that allow investors to bet on India without registration and prohibiting these instruments from being issued against derivatives for speculation.   
  • The new rules are in addition to enhanced disclosures to prevent P-notes misuse. Making issuance expensive will lead to a further fall. Rightly, the norms for direct participation of overseas investors in the stock market, too, have been greatly simplified. 
  • Now, SEBI must give leeway to allow P-notes on a very selective basis for bona fide investors like college endowments whose identification it’s comfortable with. The regulator should also be watchful that rules to curb volatility don’t stifle the overall derivatives market. 
  • Similarly India should build on Aadhaar to provide all legal entities, and not just individuals, a unique identifier for transparency on beneficial owners. 
  • In this backdrop the SEBI move welcome. As a signatory to the automatic exchange of tax information, India will benefit with standardised and interlinked registries.

Conclusion-

P-notes have been grossly misused for various illegal activities, hence there is an urgent necessity to make effective regulation on usage of P-notes. The proposed changes are aimed to tighten the rules for P-notes. If implemented effectively, these norms will contain the money laundering cases to great extent.


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