Spike in P-Note investments raise alarm
28 March 2014
The surge in participatory note (P-Note) investment in stock markets has emerged as a worrying feature ahead of the general elections as the route can be used to bring in black money into the country.
With foreign funds pouring into the stock markets, the Sensex on Friday scaled a new historic high for the fifth day in a row and the rupee for the first time in eight months strengthened to 60.
However, the P-Note component of the foreign institutional investor (FII) flow is seen as a disturbing trend. Investment in shares through P-Notes is a preferred route for high networth individuals (HNIs) and hedge funds from abroad as it allows them to invest in domestic markets through registered FIIs while saving on time and costs associated with direct registrations.
However, senior income tax officials are of the view that P-Notes are also being used by Indians to reinvest black money in the country. A senior official told MAIL TODAY that P-Notes enable investors to keep their identity anonymous. This is possible as P-Notes can be freely traded and easily transferred without disclosing the identity of the actual beneficiaries.
The official added that the onus of knowing the ultimate beneficiary of P-Notes is on FIIs there have been instances where FIIs have failed to do this.
There are several reissues of P-notes, which makes it difficult to track the ultimate beneficiary. This had also been highlighted in a white paper tabled in Parliament, the official further added.
The white paper also admits that since P-Notes are issued from offshore financial centres such as Cayman Islands, British Virgin Islands, Switzerland and Luxembourg, it is possible to hide the identity of ultimate beneficiaries through multiple layers.
The Securities and Exchange Board of India (Sebi) has been taking measures to check the use of these instruments for black money laundering. While Sebi has laid down know-your-customer (KYC) norms for FIIs, it is the multiple transfer of P-Notes that makes this measure ineffective. "If the government or Sebi cannot track down the ultimate beneficiary of the P-Notes, the whole purpose of KYC is defeated," a senior official added.
Sebi tightened norms for issue of P-Notes by overseas investors in January by barring 'unregulated' foreign funds from dealing in offshore derivative instruments. These guidelines are aimed at providing more stringent oversight of PNotes. However, Sebi in the past has had to take action against reputed players like UBS Securities and Barclays due to non-compliance with KYC norms.
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Book Review:
http://www.dnaindia.com/lifestyle/review-book-review-sense-sensex-and-sensibilities-the-failure-of-india-s-financial-sentinels-1588442
'Sense, Sensex And Sensibilities: The Failure Of India’s Financial Sentinels'
18 September 2011
Both the government and the Opposition, as well as financial sentinels like the RBI and SEBI, seem reluctant to enforce rules that can prevent corporate money laundering.
Book: Sense, Sensex And Sensibilities: The Failure Of India’s Financial Sentinels Author: MR VenkateshPublishers: KW PublishersPages: 336
For developing nations, the black markets induced by a recession are a bigger menace than the recession itself. The illicit global economy is a hydra-headed monster, affecting the ‘peripheral economies’ (smaller economies on the border of global trade) the most.
In fact, between 2000 and 2008, the outflow of illicit capital from India was estimated at $104 billion. InSense, Sensex And Sensibilities, MR Venkatesh, a chartered accountant and commentator on trade and economic affairs, holds the Indian ruling class responsible for the rampant money laundering that has flourished in India since the onset of liberalisation and privatisation.
The Securities scam of 1992, the Ketan Parekh scam of 2001, and the 2G and CWG scams of 2011 are some of the infamous examples.
A study by the Global Financial Integrity, a Washington-based organisation that aims to curtail illicit financial flow, estimates that in 2006, developing economies lost $1 trillion due to black money. MR Venkatesh has done a creditable job of compiling extensive data on the ‘volatile’ black market, and interpreting it financially and legally.
Take participatory notes (PNs) for example: PNs are non-transparent derivative instruments used by investors who are not registered with the SEBI (Securities and Exchange Board of India) to invest in Indian securities.
PNs are instruments that derive their value from an underlying financial instrument such as an equity share.
The SEBI permitted foreign institutional investors (FIIs) to register and participate in the Indian stock market in 1992. India-based brokerages buy India-based securities, and issue PNs to foreign investors. Dividends from the underlying securities go back to the investors.
Incredible as it may appear, the only national leader who has demanded disclosure of names and whereabouts of PN holders was AIADMK chief J Jayalalithaa, by no means a politician renowned for her integrity. On the other hand, every finance minister — be it of NDA or the UPA regime — has rejected the suggestion. Even the RBI is all for restricting PN transactions, but the SEBI is not.
The total value of “underlying investments by the PNs was estimated at Rs67,000 crores”, or 26% of cumulative net investments by the FIIs at the end of 2005. And yet, neither SEBI nor the government of India seem concerned about this tradable instrument, or about the identities of the PN holders.
This seems incredible when even the parliamentary committee on finance has conceded that a “legislative framework alone is not enough, because tax-evaders keep shifting their operations”.
The loss to the national exchequer went up from Rs72,881 crore in 2009-10 to Rs88,263 crore in 2010-11, thanks to the bonanza offered to corporates.
Complex structures, such as legal entities operated by intermediaries working in secrecy jurisdictions (mechanisms used to facilitate illicit financial flows), mostly help the black market.
For India, the offshore trust created in Mauritius is a catalyst for tax evasion. Offshore companies are often registered in tax havens such as the Isle of Man and Mauritius.
Beneficiaries of this structure (nominee directors and shareholders) are apparently disassociated from the original trust.
These tax havens are aggressively marketed by financial intermediaries to potential clients through mainstream publications such as The Economist, with advertisements openly inviting illicit funds.
Amusingly, capital is almost completely mobile, be-fooling the police in cross-border black-money transfers, and the judiciary is toothless here.
The chapters on ‘plunder’, ‘money laundering’, ‘sleeping watchdogs’ and ‘deliberately weak statutes’ contain clinical scans of how illicit capital is siphoned out of India via the hawala route, and then redirected back into the country as foreign investment.
The collusive roles of national elites and international commercial and criminal interests in this vicious cycle are exposed, suggesting that the national laws and regulations are but a cruel joke.
Governments and multilateral agencies relate dirty money with narco-terrorism, but only casually. The World Bank and the IMF, too, are strangely uninterested in investigating or quantifying illicit financial flows and tax evasion.
But the corruption debate has to expand beyond dishonest politicians and government officials. Financial intermediaries engaged in transacting illicit cross-border financial flow via offshore centres into the mainstream banking system should be nabbed without delay.
There are discreet legal instruments used by MNCs and plutocrats for tax evasion. Their links with criminal activities — such as market rigging, insider trading, payment of political donations, embezzlement, fraud, and bribery — are a threat to democratic politics.
Sense, Sensex And Sensibilities is an insightful and informative narrative on how informal economies are weakening the official economy.
Venkatesh believes that things can be remedied if the government and statutory bodies decide to stick to the rule book.
For instance, the SEBI and the RBI have the power and ability to “get at the root of the PN conundrum”, and the government should unearth illicit deposits abroad such as those stashed in the LGT Bank.
But then, this is likely to remain just wishful thinking, given that India is controlled by an oligarchic nexus of politicians and businessmen that has no state and no social commitment.
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