Participatory notes are issued by FIIs to their unregistered clients who want to invest in the Indian equity market but do not want to meet the disclosure requirements to do so. Thus the modus operandi they opt for is to invest their money with the fund companies (FIIs), who will invest in Indian market on their behalf. The fund company is registered with SEBI in India and issues participatory notes to these investors as a proof of their investment. Participatory notes are instruments used by foreign funds not registered in the country to trade in the domestic market. SEBI’s Concern and rulings regarding these notes:
Participatory Notes have always been a bone of contention for SEBI as the identity of the investors is not known. In 2003, there was a boom in the stock market mainly due to a lot of foreign funds. This also led to a lot of volatility in the Indian market because a lot of Investment was done through Participatory Notes. So in 2003, SEBI amended regulations relating to foreign institutional investors to incorporate a new 10 point code of conduct and inserted a clause seeking disclosure of information with regard to participatory notes. The code seeks compliance to good corporate governance standards and SEBI regulations. SEBI has clarified that there is no change in the rules relating to FIIs except for the strengthening of KYC Norms. They have also given a ruling which states that from Now on, The PNs can only be issued to Registered Entities. The actual investing parties must be registered with the regulator of their country of Incorporation. In addition, to facilitate the process of transition, derivative instruments already issued and outstanding against un-regulated entities will not be required to be terminated immediately. It has been decided that the said contracts will be permitted to expire or to be wound - down on maturity, or within a period of 5 years, whichever is earlier.