Capital and commodities market regulator SEBI will amend the Foreign Portfolio Investors regulations to formally bar Indians, non-resident Indians and entities beneficially owned by NRIs from being beneficial owners of participatory notes. A decision to this effect will be taken at the upcoming board meet on April 26.

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, feels the regulator.

Also, the move will help curb round-tripping of funds to evade taxes, feel experts.

Siddharth Shah, Partner at Khaitan & Co, told Moneycontrol: “It is important to have clear regulations for NRIs investing in the Indian markets. Restrictions on using Offshore Derivative Instruments to invest in India may be driven by the motive of curtailing the risk around flow of unaccounted offshore and onshore money into the market and would encourage more direct investments”.

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. It is near impossible for SEBI to keep track of every entity to which P-notes are issued.