Mumbai: Allaying concerns about any further misuse of participatory notes, or 'P-Notes', Securities and Exchange Board of India Chairman U K Sinha has said Indians can no longer use these offshore instruments, even indirectly, and a strong safety net has been put in place to check any routing of black money.
He also said that foreign investors have been taken "completely on board" for changes in the regulations governing offshore derivative instruments (ODIs) - commonly known as P-Notes - and they have been consulted even for design of the reporting formats about investments through this route.
Market watchdog Sebi will soon finalise reporting formats as also the revised guidelines and new circulars, for foreign portfolio investors (FPIs) dealing in ODIs, after incorporating the changes approved by its board earlier this month.
While foreign investors can register themselves as FPIs to invest directly in India, ODIs are typically market-access instruments preferred by those looking to save on time and operational costs involved with a direct registration.
Sebi rules allow certain classes of FPIs to issue ODIs after a proper due-diligence process that has been further tightened now to address the concerns raised by the Special Investigation Team (SIT) on black money.
In an interaction here, the Sebi chief said India wants to encourage and promote long-term investments and would prefer foreign investors to come directly, but there will be no roadblocks for genuine investments even through P-Notes.
Ruling out any special concession for the investors using this route, including hedge funds, Mr Sinha said that if some investors have a genuine reason such as "testing the Indian waters", they can use ODIs after complying with the due KYC (know your customer) and other regulatory requirements.
"In the past, this route was misused by some Indian nationals and Indian corporates for getting their ill-gotten money rerouted to the Indian markets."
"The intention was also to put money into their own firms so as to manipulate the share prices. As late as 2007-2008, we found some such cases and took action," Mr Sinha said.
"Now, Sebi has got the information and a guarantee from the foreign investors issuing ODIs that not a single Indian has been issued such instruments and they would not be allowed to subscribe to these instruments, directly or indirectly."
"Earlier, there were also cases about some hedge funds camouflaging their identity and come through this route, but that is also not possible now and Sebi has got full details till the last possible end beneficial owner," he added.
ODIs now account for investments worth Rs 2.12 lakh crore in Indian markets, which is 9.3 per cent of the overall FPI investments - down from a peak of over 55 per cent in 2007.
Mr Sinha said he sees this percentage falling even further, as foreign investors are preferring the direct route and hundreds of new FPIs are getting registered every quarter. Even among FPIs, broad-based funds with low-risk profile account for well over 95 per cent of investments into the Indian markets at about Rs 22 lakh crore, while presence of high-risk investors such as hedge funds is very small - both in terms of their number as well as the investments.
Sebi classifies FPIs into three categories based on their risk profile and they are subjected to the KYC requirements accordingly.
Category-I FPIs mostly include central banks and sovereign funds, while Category-II comprises of broad-based investors such as mutual funds, insurers, pension funds and banks. Category III is the highest-risk category and includes hedge funds and other smaller investors.
The third-category of investors are not allowed to deal in ODIs, while only some in the second category are permitted to issue or subscribe to these instruments.
Sharing further details, Mr Sinha said investments by Category-III FPIs currently stand at only about Rs 77,000 crore while their count is just about 600. In comparison, there are over 7,000 Category-II FPIs and they have invested over Rs 18,74,000 crore. There are about 300 Category I FPIs that have invested close to Rs 3,30,000 crore in India.
ODIs are issued abroad by FPIs as market access products against securities held by them that are listed or are proposed to be listed on a stock exchange in India, as its underlying.
These underlying securities can be equity, debt, derivatives, index, a basket of securities from different jurisdictions, or a basket of all Indian securities.
The ODIs include over-the-counter derivatives documented through a bilateral contract, as also the securitized instruments such as notes, certificates or warrants.
Mr Sinha said there have been two extreme sets of worries in the public's mind: "One is that Sebi is not doing enough to prevent the flow of black money and whether whatever Sebi has done is good enough. The worry on the other side is that are we killing this instrument and what would be the impact on the markets?"
"Even before we decided on the latest changes, there were worries that it would affect the markets. I remember this decision was taken on a Thursday afternoon and my colleagues kept calling me the previous night and in the morning that they are worried about the markets."
"Personally, I was not worried because we had held a series of detailed consultations with the FPIs. After the decision also, we called them, as based on these decisions we need to issue some circulars, some guidelines and also some formats need to designed," he said.
"Even to the extent of designing these formats, we have consulted them so that they are on board and they realise what is the rationale behind it."
Mr Sinha said that the intention of the government and Sebi has been always clear that any inclination among genuine investors to come through PNs and not the direct FPI route must be removed.
"That is why we have made the FPI registration process very simple and for those using PNs we have brought in more and more transparency so that the difference between the two routes becomes less and less," he said.
Assuring that rules are strong enough to check any misuse, Mr Sinha said P-Notes or ODIs still form part of an important and genuine business requirement.
"We don't frown upon these instruments. We have seen these instruments are used all over the world and many jurisdictions allow them as many investors need these instruments as a genuine business requirement," he added.
"At the same time, the effort has been to remove the dichotomy between these two sets of foreign investors - FPIs and ODIs - and bring them together as far as legitimate investors are concerned."
"We have focussed on making FPI registration process simple and ensure proper KYC compliance."
"One of the worries earlier was that Sebi did not know who were the ODI holders -- In which jurisdictions they were and whether they were Indian nationals or not," he said.
"Over the years, Sebi has put in place a very detailed mechanism for reporting requirements of FPIs and that provided for who are the ODI holders and which jurisdictions they were in, among other things."
"Some people may find it hard to believe, probably because of their own bad experiences in the market in the past, but Sebi now has full details about each and every ODI holder at the end of every month."
"So, the earlier possibility of Indian nationals using the ODI route is not possible. There were a variety of routes earlier and the one such route was Protected Cell Companies which had a very opaque structures. Sebi has ensured that no such opaque structures are being used now."
Mr Sinha said it was not very easy to persuade the FPIs for the changes. In the past, whenever Sebi wanted to tighten the ODI rules, there used to be a serious impact on the markets.
"So, learning from the past, we began consulting the industry on any proposal to bring in new changes."
"There are about 8,000 FPIs registered today, out of which only 39 issue ODIs. We consulted all of them. We had extensive consultations and we explained to them that what SIT was saying and what was the reason behind it. After convincing them, we went to our Board and it took a decision," he said.
"The idea has been that let us make FPI process so much simple that the genuine investors are not inclined to go to this route. But there would still be some people who want to use this form genuine reasons, such as those who just want to test the Indian waters and do not want to get registered as FPIs initially."
"FPIs and ODI issuers are also realising that it is not something which is happening only in India, but it is a global movement against black money and in favour of transparency," he said.
The Sebi chief said the regulator's consultations with FPIs show that more and more people have begun coming directly as FPIs as the process has been made very simple.