What are Participatory notes? Why is it in controversy? What does Lahiri Committee report say with respect to Participatory notes? (250 words)

‘Participatory notes’ are instruments that derive their value from an underlying financial instrument such as an equity share and, hence, the word, ‘derivative instruments’.

Financial instruments used by investors are hedge funds that are not registered with the Securities and Exchange Board of India to invest in Indian securities. Indian-based brokerages buy India-based securities and then issue participatory notes to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investors.

Negative side

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.

Terror financiers who could find this route attractive and simple.

Unknown foreign entities spells danger for domestic companies since the unknown entity may be targeting the local company without its knowledge. With reasonable control they can pressure the current owners to settle with them or even try taking over.

Lahiri Committee’s report

The Lahiri Committee on `Encouraging FII flows and checking the vulnerability of capital markets to speculative flows’ had debated the issue of PNs in detail. While taking note of the possibility of misuse of the instrument, the panel had favoured the continuation PNs with the rider that “SEBI should have full powers to obtain information regarding the final holder/beneficiaries or of any holder at any point of time in case of any investigation or surveillance action.”

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