Participatory notes (P-Notes) allow foreign investors to invest in Indian stock markets without directly registering with the market regulator SEBI. The Supreme Court has asked SEBI to issue guidelines to curb the flow of black money through P-Notes by better identifying their real owners. In response, the Indian stock market fell over 500 points on concerns that restrictions on P-Notes could reduce foreign investment inflows. SEBI has taken measures like increased reporting requirements and restrictions on certain types of P-Notes to balance curbing black money while not unduly impacting foreign investment.

1. The Indian stock market is under stress due to Supreme Court guided SIT which has asked SEBI
to set a guideline in relation with ownership of P-Notes, to curb flow of Black Money. The
Sensex shed 553 points on 27th
July and P Notes were in News. Lets understand what is
Participatory Notes
What are P-Notes?
There are foreign individuals who wish to invest in Indian (or another country) stock market,
without registering themselves with Market regulator (SEBI in India).1992 onwards SEBI has
allowed foreign institutional investors to register and participate in Indian market.
Participatory Notes or PN or P-notes are issued by such foreign brokerages registered with SEBI
or the foreign arms of domestic brokerages to these overseas investors, who do not want to
disclose their identity. These broker buys Indian securities (shares, debt or derivatives) on
behalf of such investors and issues P-notes to them for
a fee.
These P-Notes are extremely popular with foreigners
as it saves their time and identification.
How it Functions?
Many fund managers/ Hedge Funds/Overseas
Investors don’t want to get registered with SEBI as
foreign institutional investors (FII), but want to make
money in stock markets. They contact a foreign
broking house registered as an institutional investor in
India and ask it to buy shares in the local market, and
issue a synthetic share by way of a PN.
Who uses the PN route?
Among EM (Emerging Markets) Indian Stock Exchange has consistently given highest return.
Hence it attracts majority of FII participation at world scenario. It is not easy to enlist who want
to use PN route, but still we can classify them into these 4 categories.
1. The first category is the regular funds whose twin objectives are returns and more
returns on a 21*7*365 basis
2. The second category is the Indian sportsman/actors/politician/businessman who has
accumulated wealth abroad. This has been accumulated by under-invoicing/over-
invoicing, by corruption in contracts and gifts from abroad; and by not bringing in
legitimate receipts.
3. The third category is those foreign governments/entities who would like to
acquire/control Indian entities by taking them over.
4. The fourth category is the terror financiers who could find this route attractive and
simple.

2. Investment by FIIs through Participatory Notes
The positions held through P-notes are worth Rs 2,75,436 crore or 11.5 per cent of the assets
under custody of foreign portfolio investors, which isRs23,86,457 crore. Though nowhere close
to their high of Rs 4,49,613 crore during the peak of the previous bull run in October 2007, the
government and SEBI worry that remarks on restrictions on P-notes can spook investors. Clamp
down on transfer of P-notes could result in a fall in foreign portfolio inflows.
Why Supreme Court is concerned about P Notes ?
A Supreme Court appointed Special Investigation Team (SIT)
entrusted with the task of suggesting measures to curb black
money recommended SEBI should do more to identify real
owners of P-notes and restrict their transfer. SEBI already has the
powers to seek information from the broker on who is it issuing.
But, in some layered transactions, the end beneficiary could be
different from the first P-note buyer. The SIT had suggested SEBI
to put in place regulations to help identify individuals holding
participatory notes or offshore derivative instruments (ODIs), and
take other steps required to curb black money and tax evasion
through the stock market route.
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3. Impact of P Notes news on Indian Stock Market
The P-Note holders, who are not registered with SEBI, tend to pull out funds at the slightest
hint of trouble in local markets. Hence, the government had asked capital market regulator SEBI
to take more proactive steps to track the transactions and restrict their transfer.
Indian stock market BSE fallen to 27561 (1.88%) on 27th
July 2015, on twin impact of SIT
announcement on P-Notes and fall in China Stock Market. Rupee also fell by another 12 paisa to
6-week low of 64.16 per Dollar.
On the 16th of October, 2007, SEBI has proposed curbs on participatory notes which accounted
for roughly 50% of FII investment in 2007. However the proposals of SEBI were not clear and
this led to a knee-jerk crash when the markets opened on the following day (October 17, 2007).
Within a minute of opening trade, the Sensex crashed by 1744 points or about 9% of its value -
the biggest intra-day fall in Indian stock-markets in absolute terms
Measures taken by regulator to make a balance
PNs will never be phased out completely subjected to market sentiments. However SEBI has
taken measures so that percentage of PN among FII should be reduced substantially. As a result
of this participation through PN has reduced from 51% in 2007 to 11% in 2015
The primary causes cited are:-]
 Regulatory changes - SEBI banned Overseas Derivative Instruments (ODI) and asked FIIs
to decrease PN participation to 40%
 Alternatives - FII registration was made easier
In June 2012, SEBI ordered FIIs to report monthly details of P-notes transactions within 10 days.
Earlier, FIIs were given a time of six months for such reporting.
On November 24th 2014 SEBI issued new norms to curb illegal funds inflow. The new norms will
enhance KYC and shut out entities form opaque and non-transparent structure to filter the kind
of money that flows into the country.
SEBI has also said that sub-accounts (the mechanism through which FIIs issue PNs) could stay,
provided they register. As per the new regulations issued by SEBI, FIIs and their subaccounts
cannot issue/renew ODIs with underlying as derivatives with immediate effect. They are
required to wind up the current position over 18 months.