P-note derivative assets plunge 82% since July

The share of participatory notes (p-notes) in the country's total foreign portfolio assets hit a new all-time low of 4.1 per cent in August. 

Their investments in derivatives have nosedived 82 per cent since July, after the ban on naked positions. P-note assets in the derivatives segment were Rs 8,645 crore in end-August, down from Rs 47,674 crore in end-May.

In absolute terms, the value of p-note investment in domestic equity, debt and derivatives (notional) stood at Rs 1.25 lakh crore at the end of August, down 42 per cent in one year, show data from the Securities and Exchange Board of India (Sebi). This is despite the benchmark Nifty going up 11 per cent in the past year. The share of p-notes in foreign portfolio investment (FPI) assets has more than halved to 4.1 per cent, from 8.4 per cent in August 2016. Their share was at a peak of 55.7 per cent in June 2007. 

Continuous tightening of the p-note rules framework, amid fear of misuse, has dimmed the appeal of this investment route. Most FPIs now prefer direct investment instead.

Experts say eligibility and other criteria for a p-note subscriber are now at par with those for an onshore investor. Also, the cost advantage offered by p-notes over direct investing has got blunted by the regulatory tightening. 

From July, the issue of p-notes in the derivatives market was only allowed for hedging. In other words, a p-note subscriber is allowed to deal in the derivative of a stock only if owning the same stock in the cash segment.  Sebi has also introduced a 'regulatory fee' of $1,000 for every three years on p-note issuers, for every subscriber. 

Investments through p-notes have been on a downward spiral since May 2016, after Sebi had made one of the most comprehensive changes to the framework. The market regulator said Know Your Customer and anti-money laundering (AML) rules applicable to Indians were to apply for p-note subscribers. With this, Sebi tried to put an end to the regulatory arbitrage the p-note holders enjoyed by not having to register with Indian regulators.  As a result, market players say the business had become unviable for many issuers. In the past year, big brokerages HSBC and UBS have exited the p-note issuance business.