Capital and commodities market regulatory authority SEBI is set to amend the FPI regulations to formally bar Indians, NRIs and entities beneficially owned by NRIs from being beneficial owners of participatory notes.
PNs are derivative instruments issued by foreign institutional investors to overseas clients who want to invest in Indian securities, but do not want to register with SEBI, for reasons perfectly legitimate or even dubious.
The underlying asset could be shares, derivatives or debentures.
Till now, the restriction on Indians and NRIs from being beneficial owners was imposed by way of Frequently Asked Questions on the regulator’s website.
The move to include this in FPI regulations will give the restriction more legal sanctity.
Also, the move will help curb round-tripping of funds to evade taxes.
Often, money siphoned out of the country by inflating import bills and under-reporting export income is brought back through the stock market.
Foreign investors who invest in Indian through PNs are often fronts for Indian and NRI entities.
PNs are often onward issued, meaning, PNs issued to client A are then sold by A to the next client B.
The onward issuances - one or more - of PNs are done to create a layer to shield the actual beneficiary from the regulator's glare.
SEBI rules are clear if the PNs issued to a client A onward issued to another client B, the responsibility for identifying and the accountability for reporting the end beneficial owners rests entirely with the issuer, the FII.
But enforcing it is the biggest challenge for the regulator, given the magnitude of the foreign funds coming in through the P-note route.
At present, roughly USD 27 billion of FII holdings are through the P-note route.