The Supreme Court-appointed special investigative team's (SIT's) recommendation of stricter norms for participatory notes (P-notes), to check the flow of unaccounted money, is likely to be viewed negatively by the market.

The SIT had last week suggested the Securities and Exchange Board of India (Sebi) 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.

However, market participants suggest any sudden crackdown would not be viewed positively.

The P-note route already had strict compliance requirements, said an official with a foreign brokerage who did not wish to be named. "More restrictions on participatory notes will prove administrative and compliance hassle for foreign portfolio investors (FPIs). A huge flow of money from the Cayman Island and Mauritius routes is no tax evasion; it is tax planning by foreign investors," said Rajesh Gandhi, partner, Deloitte Haskin & Sells.

"Currently, these are just recommendations from SIT. It will eventually be for the regulator to implement. If, however, the regulator implements it, the move will be taken as a negative by the market," said Andrew Holland, chief executive officer, Ambit Investment Advisors.

Based on data from Sebi, the SIT report said a major chunk of outstanding offshore derivative instruments that invested in India were coming from the Cayman Islands (31 per cent).

"This translates into about Rs 85,006 crore. In 2010, the Cayman Islands had a population of 54,397, according to Wikipedia. It does not seem conceivable that a jurisdiction with a population of less than 55,000 could invest Rs 85,000 crore in just one country," the report said.

Another market participant who did not wish to be named said putting restrictions on transfer of P-notes would be restrictive on the transactions FPIs generally conduct. "P-notes are transferable in nature; if I do not need it any more I transfer it to another known FPI in the jurisdiction. Labelling all money coming through the ODI route black money is not accurate; these are legitimate transactions."



Another said Sebi could not make these instruments any more restrictive. "If the intention is to track illicit fund flows, the focus should be on tracking these through automatic exchange of information. Transactions through P-notes are legal and can't be viewed as evasive," the FPI said.

Earlier, a crackdown on P-notes had taken place in 2007. P-notes at that time accounted for over 50 per cent of total foreign holdings. The result: There was a drop of around 10 per cent within minutes of the market opening for the first time after announcement of the change in norms.

Trading had to be halted for an hour. Both P Chidambaram, then finance minister, and M Damodaran, then Sebi chairman, had to make statements to calm the The proposal that resulted in the fall did lead to certain curbs. These curbs, however, barely lasted a year.

Subsequently, Sebi also took steps to track beneficiaries and make it easier for foreign investors to register with the regulator and avoid the P-note route. Today,



P-notes' holdings in equity, debt and derivatives is Rs 2.75 lakh crore, or 11.53 per cent of overall FPI holdings of Rs 23.86 lakh crore, according to Sebi data.

Some, though, are hopeful that P-notes will not be shunned. "Some of the information regarding identity is already available with the issuer and is shared by them on an ad hoc basis. So, the SIT finding is unlikely to have a huge negative impact on future P-note participation," said U R Bhat, managing director, Dalton Capital.

(With inputs from Sneha Padiyath)