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Participatory Notes(PNs) — Whole system need to be cleaned !

We have seen the recent Indian stock market crash in the wake of the proposed restrictions on investments by overseas investors through Participatory Notes by SEBI.

So what does this Participatory notes mean ?

Participatory notes (PNs) are Financial instruments used by investors or hedge funds that are not registered with the Securities and Exchange Board of India to invest in Indian securities.

For example, Indian-based brokerages buy India-based securities and then issue participatory notes to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investor. According to one estimate, participatory notes constitute more than 25% of the cumulative net investments in equities by FIIs.

Indian Government, SEBI concern

  • Indian regulators are not very happy about participatory notes because they have no way to know who owns the underlying securities.
  • Recently the National Security Advisor (NSA), Mr M. K. Narayanan issued a statement, that terrorists could be manipulating the stock market in India.
  • Crucially, it has to be noted that under the existing framework, the FIIs are not bound to reveal the names of the PN holders. That makes PNs completely opaque, which goes against the well-established concepts of `Know Your Customer’ (KYC) norms.
  • Further, the FIIs are not allowed to issue PNs to Indian nationals, Persons of Indian Origin or Overseas Corporate Bodies (a majority of which are controlled by NRIs).

FIIs issuing Participatory notes (PNs)

  • Citigroup
  • Goldman Sachs
  • Merrill Lynch
  • Morgan Stanley
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