The Hindu Business Line : Chronicle of controlling PNs in India

There is hardly any authentic record of the life and living of participatory notes, issued globally against the local stocks. Existence of these controversial overseas derivatives instruments, according to Mr Pratip Kar, former (and the longest serving) executive director of SEBI, could be traced back to around 1996.

However, notoriety of PNs first noticeably came into public domain in 2001, courtesy the last Joint Parliamentary Report.

Since then, (mis)use of PNs has been called to question time and again, particularly by the RBI. Nevertheless, it survived. This time around, the market regulator allowed them another life, albeit a restricted one.

We, here attempt a sketchy chronicle from scattered bits down the memory lane on the supposed 10th anniversary of their survival.

October 2001: PNs first came on the regulatory radar, after the country’s second major securities fraud surfaced in March. SEBI established a monthly post facto reporting mechanism for the issue, renewal, redemption or cancellation of these instruments by the overseas brokerages, registered here.

August 2003: RBI sent out missives to foreign broking firms seeking PN turnover figures to check the origin and extent of the trades. The responses, however, were not made public.

October 2003: The technical committee of SEBI regulated entities, constituted by the High-power Committee on Capital & Financial Markets — apex policy level forum of the monetary, fiscal and market regulators — first met to take a hard look at PNs. It decided not to propose a ban, but subjected PNs to the know-your-client norm.

February 2004: With effect from February 3, PNs were allowed against underlying Indian securities only to regulated entities and further transfers, if any, were permitted other regulated entities. SEBI prohibited downstream issuance to unregulated entities by FIIs/sub-accounts.

May 2004: SEBI issued notice to 12 FIIs for alleged violation of the (reporting/KYC) rules in issuing PNs to their clients abroad after the May 17 crash (565 points fall on the Sensex).

Out of the dozen, UBS Securities Asia was barred from issuing PNs for a year.

Other issuers were let off from the charges of violation.

November 2005: An expert group, set up by the Union Finance Ministry, headed by Dr Ashok Lahiri, recommended continuation of PNs, but the RBI representative in a dissent note demanded a complete ban. The report said: “SEBI should have full powers to obtain information regarding the final holder/beneficiaries or any holder at any point of time in case of any investigation or surveillance action. FIIs may be obliged to provide the information to SEBI”.

RBI, however, expressed its doubts about the possibility of tracking the beneficial ownership of these multi-layered instruments.

September 2006: The Tarapore committee recommended a quick wind down of PNs. It said that FIIs should be prohibited from investing fresh money raised through PNs.

Existing PN-holders may be provided an exit route and phased out completely within one year.

A dissent note by Dr Surajit S. Bhalla, however, said the committee’s haste towards an immediate ban of PNs and immediate reversal of the existing GoI policy, without any documentation or evidence, suggested an ideological bureaucratic predisposition.

October 2007: SEBI bans fresh issue of PNs against derivatives by FIIs/sub-accounts and the positions to be wound down in 18 months.

(Compiled by Jayanta Mallick)

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