What are Participatory Notes | Participatory Notes in India

Participatory notes (PNs) are instruments used by foreign funds, not registered in India, for trading in the domestic market. The unknown investors, who buy PNs, deposit their funds in the US or European operations of the FII, which also operates in India. The FII uses its proprietary account to buys stocks in India. A government report has said that the FII or the broker acts like an exchange since it executes the trade and uses its internal accounts to settle this. Other such instruments (Offshore Derivative Instruments) include equity-linked notes, capped return note, participatory return notes and investment notes. SEBI permitted FIIs to register and participate in the Indian stock market in 1992. In India Merrill Lynch, Morgan Stanley, Credit Lyonnais, Citigroup and Goldman Sachs are the biggest issuers of PNs.

Why participatory notes are dangerous
1. The PNs are a slap on the face of every citizen who is an investor. For a person to invest even in one share, several KYC (know your customer) forms have to be filled up, and PAN numbers and proof of address, etc., provided. For the PN investor the system is totally silent on even elementary information. The FIIs issue PNs to funds/companies whose identity is not known to the Indian authorities.Hence, the PN system is blatantly discriminatory and seems to favour ghost investors.
2. Participatory notes can be used by a large number of politicians/bureaucrats/business-persons have accumulated wealth abroad. This has been accumulated by under-invoicing/over-invoicing, by corruption in contracts and gifts from abroad; and by not bringing in legitimate receipts. Tax officials fear that PNs are becoming a favourite with a host of Indian money launderers who use the instrument to first take out funds out of the country, through the hawala route, and then get it back using PNs.
3. Participatory notes can be used by those foreign governments/entities who would like to acquire/control Indian entities by taking them over.
4. It can be used by the terror financiers who could find this route attractive and simple.

Read more : http://www.thehindubusinessline.in/2007/10/24/stories/2007102450800800.htm