Sebi's New Rules on Participatory Notes

In a significant move, India's market regulator, Sebi, has barred foreign portfolio investors (FPIs) from issuing offshore derivative instruments, commonly known as P-Notes or participatory notes, that have derivatives as underlying assets. Additionally, FPIs are now prohibited from hedging their P-Notes with derivative positions on Indian bourses.

These changes are set to increase the cost of holding these assets, according to experts in FPI regulations in India. Sebi has also mandated that all FPIs issuing P-Notes must obtain ownership data of all investors holding such instruments. This requirement could lead to some investors, who prefer to remain anonymous despite having exposure to the Indian market, to liquidate their holdings, according to market players.

The new rules extend the restrictions imposed on regular investments in equities by FPIs to also include ODI investments by such entities, explained Sandeep Parekh, managing partner at Finsec Law Advisors. "In theory, these impose transparency on the nature of human owner, but in practice, we have seen several high-profile investors closing their funds because they were unable to comply with the norms," Parekh said.

Sebi stated that the rules were changed to eliminate arbitrage opportunities that some FPIs enjoyed. Earlier this year, SBI had also said that all FPIs investing in direct equity in India should maintain a list of ultimate beneficial owners of the funds and assets. The Sebi circular marks a significant step in curbing regulatory arbitrage and enhancing transparency in the ODI market, according to Suresh Swamy, partner at Price Waterhouse & Co.