Whose money is it anyway? That’s the 64-million-dollar question that comes to mind whenever there is any discussion of participatory notes (P-notes, for short). The closer we look at these instruments, the curiouser they get. For one, there is the anonymity factor: a large number of the P-note holders are faceless. Also, not much is known of the origin of the monies invested in them. It is taken for granted by most in the know that much of the money mopped up through P-notes is black money.

But first things first: what are P-notes? They are simple derivative instruments that investors not registered in India or Mauritius use to trade in Indian markets. Indian brokerages that have Mauritius-based foreign institutional investor (FII) accounts buy local securities and then issue P-notes to foreign investors. The dividends and capital gains on the investments are repatriated abroad to the investors through this mechanism. Here, brokers become the medium through which investors, most of whom wish to remain anonymous, invest in the exchange. The brokers execute trade and use their internal accounts to settle. Ever since the India growth story caught on, P-notes have become quite the rage with overseas investors. With the quantum of money entering the Indian market through this route on the rise, they have come to the forefront of the regulatory radar screens of Indian enforcement agencies.

Apart from the usual concerns related to stockmarket surges, the flows through these notes have raised questions relating to national security. The identity of investors and the quality of inflows have become major concerns. In March 2004, RBI governor Y.V. Reddy had made it clear that “...we thought it was the quantity of money that counts. We are now conscious that it is the technological and managerial skills, the work culture, and the synergies accompanying capital flows that contribute a lot more to growth”. That is, in themselves capital flows amount to nothing if the allied benefits mentioned are not evident.

Echoing these sentiments, national security advisor M.K. Narayanan recently voiced concerns that there was a real danger of the capital market being manipulated by covert operators. Of course, there are many who believe that P-notes are perfectly okay. First, FIIs cannot issue P-notes to Indians, persons of Indian origin or overseas corporate bodies that are majority-owned or controlled by NRIs. This, they say, ensures that P-notes are not used to launder money. Also, FIIs are required to report to Sebi on a monthly basis if they issue, renew, cancel or redeem P-notes.

On the other hand, the Tarapore Committee in its report on capital account convertibility in 2006 was categorical that since the nature of beneficial ownership or identity not known in the case of P-notes, unlike in the FIIs, brokerages should not be allowed to raise fresh money through P-notes. It also suggested that the existing P-note holders be phased out within one year. Tarapore’s contention has all along been that the anonymity factor has been stretched. A committee member Surjit S. Bhalla dissenter, however. He said then, “...both the foreigner and NRI pay a hefty premium to a firm, which has managed to get the licence to operate in the Indian stockmarket…. The Licence Raj has shifted from the industrial sector to the financial sector. Instead of reforming this ‘Licence Raj’, the Committee, by recommending a ban on P-notes, is recommending a significant move backwards.”

The idea of anti-money laundering legislation is still developing in India. The first steps in that direction was taken with ratification of the Prevention of Money Laundering Act. The introduction of the ‘know your customer’ norms will further help take the process along. Yet, as the case of Roopalben Panchal — who opened multiple fake demat accounts and raised funds through the branches of Bharat Overseas Bank to subscribe to Yes Bank’s maiden public offer — shows, India has a long way to go.