P Chidambaram's insatiable lust for Participatory Notes (P-notes), the instruments that were a darling of India's stock market under his tenure as finance minister, is a legendary tale since they were used to launder black money. P-notes, also known as the offshore derivative instruments (ODIs) that turned Black Money lying overseas into white and made it easy to pump it into the stock markets, was the first casualty after the BJP snatched power from the Congress in 2014. Then, market regulator SEBI imposed severe curbs on P-note issuances by foreign institutional investors limiting its use. Consequently, P-notes investments that once constituted nearly 40-50 per cent of FII investments in India under Chidambaram's watch, fell to less than 5 per cent in 10 years of Modi Sarkar. But now the administration has worked out a reentry for P-notes or ODIs. On May 2, the GIFT City Regulator IFSCA said SEBI registered non-bank foreign portfolio investors (FPIs), meaning all FPIs, will now be allowed to issue P-notes. This is the latest in the slew of measures that have been announced over the past one year to popularise P-notes again. Experts say, P-notes are being allowed but with specified reporting norms.
"As a second phase, it has now been decided to permit IFSCA registered non-bank entities, registered with SEBI as FPIs, to issue (Offshore) Derivative Instruments with Indian securities as underlying, in GIFT-IFSC," a circular said.
In her Budget 2023, FM Sitharaman had made way for the controversial derivative instruments to re-enter India's stock market. In the Budget 2024 finance bill, she extended the timeline for banks to set up an arm to issue P-Notes up to March 2025. Now, IFSCA has said even SebiI-registered non-bank FPIs can issue P-notes. This is a marked easing of the law surrounding the black money instruments by the incumbent government.
The majority of India's stock market investments come from tax havens like Singapore, Mauritius, Hong Kong, Dubai and Luxembourg. To discourage this, the government launched IFSCs (International Financial Services Centres) that have laxity in tax laws like the foreign offshore destinations. Gandhinagar-based GIFT is one such IFSC in India.
Originally, P-notes could be issued by foreign banks to clients anywhere in the world, guaranteeing them their equity holdings or derivative positions in India. However, it was seen that the majority of P-note holders were from tax havens. Banks issuing P-notes were known to SEBI and the government, but the ultimate beneficiary of these instruments remained in the shadows. This obscure nature of the instruments facilitated round-tripping of black money. But the instruments are making a comeback now albeit with more reporting norms.
"The amendment to Section 18A of the Securities Contracts (Regulation) Act, 1956, and the subsequent recognition of Offshore Derivative Instruments (ODIs) in GIFT-IFSC last year, marked a significant milestone in India's financial landscape. With the recent issuance of the IFSCA Circular dated 2 May 2024, non-bank entities, alongside IFSC Banking Units, are now authorized to issue ODIs against Indian securities. This expansion not only broadens the scope of financial activities in GIFT-IFSC but also presents opportunities for broker-dealers, finance companies, and AIFs in IFSC to engage in ODIs issuance. It's important to note that there is no relaxation from SEBI on ODI issuance, and therefore the usual restrictions on who can subscribe to ODIs continue to apply. Additionally, the issue of taxation remains a key consideration for these non-bank entities. Clarity similar to that provided for banks regarding the non-taxability of income upstreamed to investors will be essential for the smooth operation of these entities." said Suresh Swamy, Partner, Price Waterhouse & Co LLP.
A robust asset management industry along with a well-developed regulatory ecosystem is pivotal to the growth of capital markets, which are in turn critical to a developing India's economy. With a view, the government is making considerable efforts for ‘onshoring the offshore’ financial services activities to enable India to compete with established jurisdictions like Singapore, Mauritius and Hong Kong, experts say. The Standard Chartered Bank and HSBC have already started issuing ODI, sources say.
Compared to established offshore jurisdictions, GIFT is an untested regime for tax and GAAR (General Anti-Avoidance Rule) uncertainties, it is an upcoming infrastructure and ecosystem and the government is taking out-of-the-box steps to popularise it.
