The Securities and Exchange Board of India (Sebi) is looking to further tighten the noose around participatory notes (p-notes) or offshore derivatives instruments (ODIs) by imposing a complete ban on using the derivatives market. Currently, p-notes can use the derivatives market only for hedging purposes. Further, the market regulator has proposed mandating p-notes – and also foreign portfolio investors (FPIs) with segregated portfolios – to provide granular disclosures around their ultimate beneficial owners (BOs), which currently only FPIs have to provide.
The move is to plug the regulatory arbitrage that exists between those taking the p-note and segregated portfolio routes vis-à-vis the regular FPI route. It also aims to address concerns around multiple levels of leverage during the use of derivatives by ODIs, even though it is only for hedging purposes.
Sources said the ban on derivatives, if implemented, could impact outstanding investments worth Rs 3,000 crore. The regulator has proposed that existing derivatives exposure of p-notes will be required to be redeemed within a year once these proposed norms are made effective.
In a discussion paper, Sebi has said it has observed in recent years that several FPIs had high exposure to a single company or group. The regulator said this raises concerns of possible misuse of the FPI route to circumvent regulatory requirements such as the 25 per cent minimum public shareholding or preventing the open offer trigger. To address this issue, Sebi in August 2023 made additional disclosures for FPIs with over 50 per cent of their equity holdings in a single group. However, this requirement is not applicable to p-notes. “This enables a foreign investor to potentially get around the granular disclosure obligations by taking exposure through the ODI route,” Sebi has said in a paper. Similarly, FPIs that operate segregated portfolios also enjoy similar regulatory arbitrage as under the August circular, the concentration criteria and disclosure requirements in case of a breach of concentration criteria are applied at the fund level and not at each segregated portfolio level.
The regulator has now proposed that the disclosure requirements specified under the August circular be made applicable directly to p-notes and segregated portfolios of FPIs.
P-notes are used by overseas funds that want exposure to Indian markets without going through the complexities of direct registration with Sebi. Prior to 2008, this route was very popular among foreign investors, with as much as half of the inflows into the Indian markets coming through the p-note route. However, the regulatory tightening over the years dimmed their popularity. As of May 2024, less than 2 per cent of outstanding FPI assets came through this route.
First Published: Aug 07 2024 | 7:21 PM IST
