By ET Bureau From Economic Times India

NEW DELHI | MUMBAI: The Special Investigation Team (SIT) tasked with curbing black money has called for identification of beneficiaries of Participatory Notes (P-Notes) and restrictions on their transfer, suggestions that are likely to cause consternation among stock market participants.

SIT, headed by ex-Supreme Court judge MB Shah, has called on the Securities & Exchange Board of India to come up with regulations so that the “final beneficial owner” of PNotes and overseas derivative instruments (ODI) are known.

This knowledge should be at the level of the individual and not the company, SIT said, because of large inflows though these instruments.

A P-Note is a derivative instrument issued in foreign jurisdictions by a foreign institutional investor (FII) against underlying Indian securities.

“The information of ‘beneficial owner’ with Sebi should be in form of individual whose KYC (know your customer) information is known to Sebi. In no case should the KYC information end with name of a company,” the committee said. Under current regulations, Sebi can seek information about individual investors in case it suspects something is amiss. However, the institution issuing the P-Note has to carry out due diligence and ensure the P-Note owner complies with KYC norms.

Some expressed scepticism about the need for further regulation. “It is a very useful investment product. People use it for the ease of investing in India and for other commercial reasons. Sebi has robust requirements on transparency of the end investor on a continuing basis,” said Sandeep Parekh, founder, Finsec Law Advisors.

The remarks on P-Notes are among a catena of suggestions on how to crack down on black money which figure in a report submitted to the government on Friday. The report, the third submitted by the panel, also refers to alleged misuse of exemption on long-term capital gains tax on shares, generation of black money through betting in cricket and trade-based money laundering. It has also suggested restrictions on cash transactions above a particular threshold and putting in place a limit of “may be Rs 10 lakh or Rs 15 lakh” on cash holding to control unaccounted money.

P-NOTES A POPULAR TOOL

P-Notes are a popular tool for investment into India by investors who do not want to comply with rigorous disclosures. In the past, there has been concern about round-tripping of Indian money. More recently, the regulatory regime appears to have settled down.

According to Sebi data, outstanding offshore derivatives added up to Rs 2.715 lakh crore at the end of February 2015 with Cayman Islands, the US, UK, Mauritius and Bermuda contributing to 31.31%, 14.20%, 13.49%, 9.91% and 9.10%, respectively.

“The person buying P-Notes does KYC as per foreign rules. While it is issued to regulated entities and Sebi can seek information from their foreign regulators in general, you don’t know who is the actual investor behind the entity purchasing the P-Note as no document is available,” said a senior official with a foreign bank.

SIT ON CAYMAN ISLANDS

Large inflows from Cayman Islands appear to have attracted SIT’s attention. “Cayman Islands had a population of 54,397 in 2010, according to Wikipedia. It does not seem conceivable that a jurisdiction with a population of less than 55,000 could invest Rs 85,000 crore in one country,” it said, calling for clear identification of beneficiaries.

Market participants expressed puzzlement at these statements, pointing out that Cayman Islands boast of a flexible and cost-effective regime for hedge funds, which is why many have not registered as foreign portfolio investors in India and have instead come in through this tax haven. SIT’s remarks linking the low population of Cayman Islands with the quantum of investment into India betrays a lack of knowledge about how capital markets work, these participants said, as it is common practice for funds to register in low-cost jurisdictions.

TRANSFER OF P-NOTES

The committee also said that since P-Notes are transferable it is difficult to track the eventual beneficiary. “Sebi needs to examine if this provision of allowing transferring of P-Notes is in any way beneficial for easing foreign investment,” it said. Parekh of Finsec Law Advisors, however, did not see the need for restricting transfers.

“Large institutional players often transfer positions among themselves and restricting transfer would dissuade some of them from investing in India. In any case, if transfer is restricted, a person can give up the P-Note and the registered foreign investor in India can create a new position which would essentially amount to transfer,” he said. “Transferable rules vary among countries as this is an offshore instrument,” said the foreign bank official quoted earlier.

LONG-TERM CAPITAL GAINS

The lack of long-term capital gains tax on profits made on sale of shares is subject to widespread misuse for laundering black money, according to SIT.

The committee has called for an effective monitoring mechanism to study unusual rise in stock prices and follow-up action after that. “Enforcement Directorate should then be informed to take action under Prevention of Money Laundering Act for the predicate offences,” it has recommended.

The committee has also noted the use of shell companies to provide accommodation entries to launder black money. To curb this, it has called upon the Serious Fraud Investigation Office to mine the ministry of corporate Affairs database to identify such companies and share the list with other enforcement agencies. It has suggested the government should quickly frame rules relating to beneficial ownership under Section 89(4) of the Companies Act.

GENERATION OF BLACK MONEY DUE TO BETTING IN CRICKET

The panel has noted widespread cricket betting and called for measures to control this activity. “A zero tolerance approach towards any wrongdoing alone can satisfy the cry for cleansing,” it said. It has suggested that even though gambling is a state subject, “considering the fact that large amount of black money is generated and used in this sector, it is suggested that some appropriate legislative directions or rules or regulations are required to be put in place to curb the menace of such betting”.

TRADE-BASED MONEY LAUNDERING

SIT also expressed concern over trade-based money laundering through mispricing of imports and exports, which is a major means of taking money out of the country. “A strong deterrent action is needed to curb this menace,” it said.

IMAGES:
The SIT also flagged serious concerns over huge amounts of black money being used and generated in areas like betting as also in donations to schools.
SIT UP & Take Notice

For more on this story go to:
http://economictimes.indiatimes.com/articleshow/48205691.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst

See also iNews Cayman related story published July 26 2015 “Probe team raises red flag over FII funds in key sectors [Cayman Islands flagged] at: http://www.ieyenews.com/wordpress/probe-team-raises-red-flag-over-fii-funds-in-key-sectors-cayman-islands-flagged/

Related:
Major panic from FIIs over P-notes unlikely: Ridham Desai

The recommendation of Supreme Court-appointed Special Investigative Team (SIT) to go after P notes emerging from Cayman Island to stem black money is unlikely to impact market or unsettle the foreign investor community, says Ridham Desai of Morgan Stanley in an interview to Udayan Mukherjee.

By RIDHAM DESAI MD & Head of India Research, Morgan Stanley Expertise : Equity From CNBC Money Control

The SIT recommendation to go after P notes to stem black money is unlikely to impact market, says Ridham Desai, managing director at Morgan Stanley in an interview to Udayan Mukherjee. He is confident that the government will make a studied decision on the issue and rules out the possibility of the FII community panicking over P note issue. Desai, on the other hand, is worried that if GST Bill does not get passed during the Monsoon Session of parliament, it may hurt sentiment. But that is “short-term” glitch in the 3-5 year bull run, he says.

To read the whole transcript go to: http://www.moneycontrol.com/news/fii-view/major-panicfiis-over-p-notes-unlikely-ridham-desai_2165701.html