We know nothing about the beneficial owners of PNs, the quality of their money, their motivations and investment horizon; and this raises fears and concerns about their potential to influence specific stock prices or destabilise the market. Most of all, investment through PNs creates an unequal playing field between Indian and overseas investors in terms of disclosure, identification and transparency.

It is estimated that over Rs 40,000 crore of PNs have been issued abroad by foreign brokers and are actively traded in some markets. Anecdotal reports say that a significant chunk of PN subscriptions come from tax-evaded domestic money which round-trips its way to the Indian capital market. This is done through friendly overseas banks which route the investment through layers of investment entities and overseas tax havens to hide beneficial ownership. Often the investment is routed through unregulated hedge funds, which in turn channel funds through PNs.

The Securities and Exchange Board of India (Sebi) is relatively muted in its opposition to PNs, but is not comfortable with them either. Over the years, Sebi has tried to improve transparency by mandating (February 2004) that PNs can only be issued to regulated entities with “no further downstream issuance to unregulated entities”. It also demands a basic level of disclosure of beneficial ownership. However, it is obviously unable to dig deep enough because the link between certain industrialists, politicians and businessmen with specific FII sub-accounts (representing billions of dollars of investment) is an open secret in the market.

That is why, the policy debate has always recommended phasing out of PNs, but in reality, their issuance has been rising continuously. From just around 15 to 20% of net FII inflows coming through PNs in 2002-03, the figure rose to 47% in April last year and jumped further to 52% in March 2006. One corporate restructuring alone was apparently responsible for a substantial jump investment through PNs.

... contd.