Participatory Notes (PN) popularly known as PNotes has become the most preferred investment for the foreign parties. They are not used within the country they are used outside India for making investments in shares listed in the Indian stock market. In general it is used for the investment by Foreign Institutional Investors (FIIs) through offshore Derivative Instruments (ODIs) such as Participatory Notes, Equity-Linked Notes, Capped Return Notes and Participating Return Notes — have created a storm in the stock market, with SEBI coming out with a draft for discussion to regulate them.

Under the revised rules, the government feels participatory notes can’t be used for possible round-tripping of black money. Participatory notes, or P-Notes, are used by foreign investors who want to avoid regulatory hassles while investing in India. Essentially, a foreign institutional investor (FII) registered in the country buys local shares and issues P-Notes against them to the overseas entity.

They were also in news due to their discriminatory nature. For a person residing in the country who wants to invest even in one share, several KYC (know your customer) forms have to be filled up, and PAN numbers and proof of address, etc., provided. On the other side for the PN investor the system is totally silent on even elementary information. The FIIs issue PNs to funds/companies whose identity is not known to the Indian authorities.

This has been a concern at times because the identity of the investor behind the FII was not known, raising allegations of round-tripping -black money being sent overseas and brought back through this route. But any suggestion that the avenue could be closed off has always been viewed with trepidation by the market, resulted the drop in equities. Outstanding investment through P-Notes added up to Rs 2.49 lakh crore, an indication of its popularity.

Under Sebi regulations, foreign portfolio investors issuing participatory notes are required to submit monthly reports. The rumour and market reaction prompted Sebi to review and tighten rules to be followed by portfolio investors. The disclosure rules are also meant to assuage fears of so-called ‘hot money’, large amounts that exit markets quickly, destabilising them by exaggerating declines into crashes.

Since 1992, when FIIs were allowed to invest in Indian equity markets after the balance of payments crisis, an offshore market for PNs developed as a primary medium for foreign investors to invest in India. The origins of such flows stems from the bilateral tax treaty that India has had with Mauritius. The main provision of the 1983 treaty was that no resident of Mauritius would be taxed in India on capital gains arising from the sale of securities in India.

The treaty therefore gave capital gains exemption for investments routed via Mauritius. Despite the uniform reduction in capital gains tax arbitrage that existed from the early 1990s through July 2004, it is interesting to note that there has been a rapid growth in the market for PNs in the last three to four years.

Who can invest in P-Notes?

a) Any entity incorporated in a jurisdiction that requires filing of constitutional and/or other documents with a registrar of companies or comparable regulatory agency or body under the applicable companies legislation in that jurisdiction;

b) Any entity that is regulated, authorized or supervised by a central bank, such as the Bank of England, the Federal Reserve, the Hong Kong Monetary Authority, the Monetary Authority of Singapore or any other similar body provided that the entity must not only be authorised but also be regulated by the aforesaid regulatory bodies;

c) Any entity that is regulated, authorised or supervised by a securities or futures commission, such as the Financial Services Authority (UK), the Securities and Exchange Commission, the Commodities Futures Trading Commission, the Securities and Futures Commission (Hong Kong or Taiwan), Australian securities and Investments Commission(Australia) or other securities or futures authority or commission in any country , state or territory;

d) Any entity that is a member of securities or futures exchanges such as the New York Stock Exchange (Sub-account), London Stock Exchange (UK), Tokyo Stock Exchange (Japan), NASD (Sub-account) or other similar self-regulatory securities or futures authority or commission within any country, state or territory provided that the aforesaid organizations which are in the nature of self regulatory organizations are ultimately accountable to the respective securities / financial market regulators.

e) Any individual or entity (such as fund, trust, collective investment scheme, Investment Company or limited partnership) whose investment advisory function is managed by an entity satisfying the criteria of (a), (b), (c) or (d) above.

Who takes PN route

There are categories of people who take this route, the first category is the regular funds whose twin objectives are returns and more returns on a 21*7*365 basis. They are interested in India since the India story is very good and returns are attractive compared to developed markets.

The second category is prodigal money returning. It is not a secret that a large number of politicians/ bureaucrats/ business-persons have accumulated wealth abroad. This has been accumulated by underinvoicing/ over-invoicing, by corruption in contracts and gifts from abroad; and by not bringing in legitimate receipts.

The third category is those foreign governments/entities who would like to acquire/control Indian entities by taking them over. The fourth category is the terror financiers who could find this route attractive and simple.

Who gets P-Notes?

P-Notes are issued to the real investors on the basis of stocks purchased by the FII. The registered FII looks after all the transactions, which appear as proprietary trades in its books. It is not obligatory for the FIIs to disclose their client details to the Sebi, unless asked specifically.


An FII, or a foreign institutional investor, is an entity established to make investments in India. However, these FIIs need to get registered with the Securities and Exchange Board of India. Entities or funds that are eligible to get registered as FII include pension funds; mutual funds; insurance companies / reinsurance companies; investment trusts; banks; international or multilateral organisation or an agency thereof or a foreign government agency or a foreign central bank; university funds; endowments (serving broader social objectives); foundations (serving broader social objectives); and charitable trusts / charitable societies.

The following entities proposing to invest on behalf of broad based funds, are also eligible to be registered as FIIs:

  • Asset Management Companies
  • Investment Manager/Advisor
  • Institutional Portfolio Managers
  • Trustees

How does Sebi regulate FIIs?

FIIs who issue/renew/cancel/ redeem P-Notes, are required to report on a monthly basis. The report should reach the Sebi by the 7th day of the following month.

The FII merely investing/subscribing in/to the Participatory Notes or any such type of instruments/ securities with underlying Indian market securities are required to report on quarterly basis (Jan-Mar, Apr-Jun, Jul-Sep and Oct- Dec).

FIIs who do not issue PNs but have trades/holds Indian securities during the reporting quarter (Jan-Mar, Apr-Jun, Jul-Sep and Oct-Dec) require to submit ‘Nil’ undertaking on a quarterly basis.

FIIs who do not issue PNs and do not have trades/ holdings in Indian securities during the reporting quarter. (Jan-Mar, Apr-Jun, Jul-Sep and Oct-Dec): No reports required for that reporting quarter.

FIIs operating in India issue P-notes to investors and collect funds outside India which are never transmitted to India. However the FII uses their proprietary account to buy stocks for these investors. Trading through participatory notes is easy because P-notes are easily transferable by endorsement and delivery; it allows overseas investors to take advantage of the tax laws of certain preferred countries; and the anonymity of the investor is maintained, which allows large hedge funds to carry out their operations smoothly without disclosing their identity.

Though Indian regulators are not very happy about Participatory Notes because they have no way to know who owns the underlying securities. Regulators fear that hedge funds acting through Participatory Notes will cause economic volatility in India’s exchanges and has the potential to pave the way for black money to enter into the system.