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P-Note Investor = Foreign Portfolio Investor?

Published on Wed, Nov 26,2014 | 07:47, Updated at Wed, Nov 26 at 07:47Source : 

P-Note Investor = Foreign Portfolio Investor?
By: Menaka Doshi, Executive Editor, CNBC TV18

P-Notes have been a popular way for foreign investors to invest in India. These overseas derivative instruments (ODIs) come with less regulatory scrutiny and in all sorts of interesting contract variations. At the end of October 2014, outstanding P-note investments stood at Rs 2.66 trillion, including Rs 1.63 trillion in equities and the rest in debt & derivatives. It is this very p-note fascination that SEBI seems to want to curb. That’s why India’s securities market regulator has  dis-incentivised ODI investors. A circular released on Tuesday indicates that hereon ODI or p-note investors will be subject to almost the same regulatory scrutiny as a foreign portfolio investor.

In its FPI Regulations, 2014 SEBI said

22.(1) No foreign portfolio investor may issue, subscribe to or otherwise deal in offshore derivative instruments, directly or indirectly, unless the following conditions are satisfied:
(a) such offshore derivative instruments are issued only to persons who are regulated by an appropriate foreign regulatory authority;
(b) such offshore derivative instruments are issued after compliance with ‘know your client’ norms:

But now there are more criteria that ODI investors need to meet. Here are the 3 big changes brought about by the circular.

Here onwards ODIs can be issued only to an investor who is a resident in a country which is
1) FATF compliant
2) where the securities market regulator is an IOSCO signatory
3) and where the central bank is a BIS member

These are criteria applicable to FPIs…now the same criteria will apply to ODI investors!

The SEBI circular says ‘An FPI shall issue ODIs only to those subscribers which do not have opaque structure’. Again, this was a restriction applied to FPI investors, now the same is being applied to ODI investors!

As you may know, an FPI (or many FPIs belonging to the same group) can own upto 10% in a listed stock. Now…the ODI investments made by an FPI will also be counted towards the 10% limit.  Here again an ODI investor is being treated on par with a Foreign Portfolio Investor!

Lawyers and bankers tell me this maybe to stop those foreign investors that were trying to conceal their ‘more than 10%’ stake in a listed company, using ODIs. But it will also mean a restructuring of strategic investment structures, where say a PE investment was split between an FPI investment of 10% and further stakes via ODI investments.

The exact impact of Tuesday’s circular is difficult to quantify, bankers are still figuring it out with their p-note clients. But remember this – ODIs such as p-notes are often used by those investors who can’t be bothered having to go through the FPI route and its accompanying scrutiny. ODIs have other advantages as well, but reduced regulatory procedure is a big one. Now SEBI says it is  ‘aligning the applicable eligibility and investment norms between ODI & FPI’. This alignment will dis-incentivise ODI investors . So, essentially SEBI is narrowing the gap between overseas derivative instruments & FPI regulations. It is reducing the arbitrage between ODI & FPI.

Bankers and lawyers are still working through some implementation challenges accompanying Tuesday’s circular. One of them spoke to me about ‘grandfathering’ confusion. The FPI regs grandfather existing ODI positions in perpetuity, he said. But the Tuesday circular offers grandfathering only till the end of the ODI contract.

Then there’s the issue of how to comply – should the FPI rely on a declaration from the ODI investor regarding compliance with the 10% limit? Or will the FPI have to do its own diligence on this count? Will that discourage FPIs from issuing ODIs?

All this could definitely impact markets as investors comprehend the full implications and positions are changed in order to be in compliance.

That said, there’s no mistaking that this is a big change in SEBI’s stance towards ODIs or P-notes! And a significant change for how foreign investors invest in India.


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