there are 1,675 registered FIIs and 5,204 registered sub-accounts.

the total share of P-note investments fell from 19.8 per cent in October 2008 to
15.5 per cent in June 2009. This implies that a majority of investments came
from registered FIIs and their sub-accounts. P-note investments had hit peak in
September 2007 at 51 per cent. Former Sebi Chairman M Damodaran had
proposed to ban investments through P-notes in October 2007.

P-notes also expose the holder to a counter-party risk, so at a time when a lot of
large institutions were going bust, investors found it safer to come directly rather
then expose
1.

1. It keeps the investor anonymous

2. It saves cost of record keeping, transaction cost, and regulatory compliance
overseas especially for small investors.
3. Thus investor use PN to enter the Indian market in a small way and then when
they are established, they shift to full-fleged FII structure.
2. What are the Problem with the instrument? It is tough to establish the beneficial
ownership or the identity of original investor. The investor may sell the PN to others, and
thus further layers. PN is also becoming favorite with many Indian Money Launderers, who
use it to first ship out money of country through Hawala and then get it back using PNs.
3. What is the extent to which PN's are used? Over the years the use of PNs have
increased from 17 FII issuing it in 2005 to over 2 dozen funds now.Merrill Lynch, Morgan
Stanley, Credit Lyonnais, citigroups and Goldman Sachs are the biggest issuers. Currently
51.4% of all assets under FII are under PN now a days
4. What are P-Notes?

It may be recalled that the Securities and Exchange Board of India had first raised the issue of participatory
notes through a circular in October 2001.

The circular said some FIIs were issuing derivatives/financial instruments against underlying Indian securities.

The circular had said these instruments were known by various names such as participatory notes, equity-
linked notes, capped return notes and participating return notes.

With a view to monitoring the investment by FIIs through participatory notes, Sebi had decided that FIIs must
report details of these instruments along with the names of the holders of these instruments.

In order to increase transparency, Sebi had in October 2001 issued a circular to all FIIs and their custodians
advising them to report to the regulator as and when any derivative instrument with Indian underlying
securities were issued/renewed/redeemed by them either on their own account or on behalf of sub-accounts
registered with them.

Accordingly, FIIs are sending reports from time to time whenever they are issuing PNs. The disclosures in the
reports submitted by FIIs are to be enhanced.
SEBI has ruled that FIIs holding P-notes that account for less than 40 per cent of their assets
under custody (AUC) can issue further P-notes to increase the outstanding proportion to 40 per
cent, but at an incremental rate of 5 per cent of AUC per year. However, FIIs with outstanding P-
notes exceeding 40 per cent of AUC on September 30, can issue fresh P-notes only on a
cancellation or redemption of existing instruments.