Participatory Note

• Participatory Note is a significant topic in the Economy Section of the UPSC IAS Exam. 
• Participatory Notes, or P-Notes (or PNs), are financial instruments issued by registered foreign institutional investors (FIIs) to international offshore investors seeking to invest in Indian stock markets without registering with the market regulator, the Securities and Exchange Board of India (SEBI).

What are the Participatory Notes?

• P-notes, or Offshore Derivative Instruments (ODIs), are issued by registered Foreign Portfolio Investors (FPIs) to overseas investors seeking involvement in the Indian stock markets without direct registration. 
• P-notes are backed by Indian stocks. FPIs, non-residents, invest in various Indian securities such as shares, government bonds, corporate bonds, etc. 
• Despite relaxed registration requirements for P-note holders, they must undergo stringent due diligence by the Security and Exchange Board of India (SEBI).

What are the reasons for Declining P- Notes?

• Uncertainty persists regarding inflation levels and the actions of the US Federal Reserve (Fed).
• The decline in P-Notes is attributed to the tightening of monetary policy by the US Fed, which has been actively raising rates to combat inflation. 
• Similar actions are being taken by central banks in Britain and the Eurozone.
• Currency correction has occurred significantly. 
• In financial markets, a correction denotes a price rebound following a trend impulse. Such corrections bring prices back in line with the overall trend. 
• They typically occur due to overselling or overbuying of instruments. 
• The reduction in P-Notes is partly attributed to market corrections affecting equity and debt portfolios.

What are the Expectations for P-Notes in the Future?

• Equity markets are presenting enticing valuations currently. 
• Supply-chain and inflation concerns are expected to diminish in the upcoming months. 
• Markets typically anticipate shifts in the economic cycle. 
• It's anticipated that in the next one to two quarters, Foreign Portfolio Investors (FPIs) will likely reallocate capital toward Indian equities.

Steps were taken by SEBI to regulate participatory notes

• In October 2007, SEBI introduced fresh regulations, barring FIIs from issuing new participatory notes, with existing ones to be wound up within 18 months. A year later, these restrictions were lifted amidst the financial crisis.
• January 2011 saw SEBI implement new rules, requiring FIIs to comply with Know Your Customer (KYC) norms and disclose transaction details, leading to a decline in participatory note issuance.
• April 2014 witnessed SEBI's ban on unregulated foreign entities from subscribing to participatory notes
• In 2016, SEBI extended anti-money laundering rules to participatory note holders, alongside KYC norms.
• SEBI introduced fresh norms on participatory note transferability between overseas investors and increased reporting frequency in 2017. 
• Subsequently, in July 2017, SEBI prohibited foreign portfolio investors from issuing participatory notes for equity derivatives investments, allowing them only for equity hedging.
• In April 2017, as part of efforts to combat round-tripping and money laundering, SEBI barred both non-resident Indians and residents from investing in participatory notes.

Conclusion

Participatory notes continue to face regulatory scrutiny. In late 2017, Indian regulators specified that P-Notes could not engage in derivative positions in Indian markets unless for hedging purposes. This strict regulatory intervention led to a decline in P-Note investments throughout 2018, reaching a more than 9-1/2 year low in November 2018. However, investments experienced a rebound in December 2018 following relaxation of some restrictive requirements by regulators.