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SEBI tightens rules for issue of participatory notes

India Infoline News Service | Mumbai |

The SEBI guidelines, which are part of recently notified Foreign Portfolio Investor (FPI) Regulations, have come into force with immediate effect

Capital market regulator SEBI (Securities and Exchange Board of India) has tightened the norms for issue of participatory notes (P-notes).

The regulator has barred "unregulated" foreign funds from dealing in offshore derivative instruments even though their investment managers are appropriately regulated by their concerned regulators.

Participatory notes also called P-Notes are offshore derivative instruments with Indian shares as underlying assets. These instruments are used for making investments in the stock markets. However, they are not used within the country. They are used outside India for making investments in shares listed in the Indian stock market. That is why they are also called offshore derivative instruments.

The SEBI guidelines, which are part of recently notified Foreign Portfolio Investor (FPI) Regulations, have come into force with immediate effect. Participatory notes are issued by brokers and FIIs registered with SEBI. The investment is made on behalf of these foreign investors by the already registered brokers in India. 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 investors.

The brokers that issue these notes or trades in Indian securities have to mandatorily report their PN issuance status to SEBI for each quarter. These notes allow foreign high networth individuals, hedge funds and other investors to put money in Indian markets without being registered with SEBI, thus making their participation easy and smooth. P-Notes also aid in saving time and costs associated with direct registrations.

Earlier, according to the draft regulations by SEBI, it had been proposed that only 'Category-III,' or high-risk foreign investors, would be barred from issuing P-Notes.

However, the gazette notification that brought the FPI guidelines into force also prohibits certain entities under 'Category-II,' or medium-risk investors, from issuing P-Notes.

"Provided that those unregulated broad-based funds, which are classified as Category-II foreign portfolio investor by virtue of their investment manager being appropriately regulated, shall not issue, subscribe or otherwise deal in offshore derivatives instruments directly or indirectly," Sebi has said in its final FPI regulations.

The new FPI regime has classified foreign investors into three groups based on their risk profile and would eventually replace existing categories such as FIIs, their sub-accounts and qualified foreign investors.

Category-I FPIs, entities with the lowest risk, would include foreign governments and government-related foreign investors.

Category-II FPIs would include appropriately regulated broad-based funds, university funds, university-related endowments and pension funds, among others.

Category-III FPIs would include all others not eligible under the first two categories.
 

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