AIFs may be allowed to issue participatory notes from IFSC

AIFs may be allowed to issue participatory notes from IFSC

Subject : Economy

Section: Capital market

In News: Alternative investment funds (AIF)s may be allowed to issue participatory notes from IFSC.

Key Points:

• A Working group formed to assess viability of extending the facility of issuing PNs by AIFs.
• The International Financial Services Centres Authority (IFSCA) is mulling allowing alternative investment funds (AIFs) to issue offshore derivative instruments (ODIs) or participatory notes from GIFT IFSC.
•  P-notes allow overseas investors to take indirect exposure to Indian securities without registering with the country’s market regulator.
• This year’s Budget recognised ODIs as a valid contract if issued by offshore banking units registered as foreign portfolio investors (FPIs) in the International Financial Services Centre (IFSC).
• At present Sixty-three AIFs are currently registered at IFSC but not all of these are FPIs.

How it works:

• An AIF registered in IFSC will take up an FPI licence. It will buy, say, RIL shares listed on National Stock Exchange or BSE and issue a contract against that in IFSC to a non-resident or foreign investor.
• Accordingly, the AIF in IFSC will hold the RIL shares and pass on the returns to the investor at an appropriate date.

How AIF different from FII?

• Regulations will have to be tweaked to allow AIFs to manage a segregated portfolio.
• FIIs are operated as arms of foreign banks, typically get into one-on-one contracts with investors that want to invest in P-notes.
• AIFs, however, cannot get into such contracts. That’s because these funds are pooled vehicles, with returns linked to units that are assigned a common net asset value.
• Transfer of P-notes or distributions made by an offshore banking unit at an IFSC to a foreign investor is currently exempt from tax. A similar provision will have to be made available for AIFs as well.

Note: Earlier P-notes were issued with cash equities, debt or derivatives as underlying. In 2018, the market regulator banned FPIs from issuing P-notes with derivatives as underlying, except for hedging purposes. At its peak, P-note issuances formed 7-8 per cent of total FPI assets under custody. This has dwindled to about 2 per cent post the ban.