Participatory Notes (PNs) are used for investment by Foreign Institutional Investors (FIIs) through Offshore Derivative Instruments (ODIs). However, due to the notorious nature of PNs, the RBI has called the use/misuse of PNs to question time and again.

PNs are offshore derivative instruments held by entities and has been the main avenue for the officially-barred hedge funds to enter Indian markets. PN is a derivative instrument issued by Foreign Institutional Investors (FIIs) to market participants who do not reveal their identities or are not registered with the Indian regulator. The invention of this product was necessitated as many fund managers did not want to register with the Sebi as FIIs, but still wanted to participate in the stock market.

PNs confer anonymity on those who hold them. It is a derivative instrument since it `derives' its value from an underlying share or security. It allows investors to build portfolios depending on their preference for individual shares. Brokerages affiliated to FIIs buy India-based securities and then issue PNs to foreign investors. The instrument is issued through the sub-accounts of registered FIIs operating in Indian markets. Even though PN-holders do not own the shares directly, they are able to collect dividends or capital gains that accrue from the underlying assets. However, the velocity of circulation of this instrument is enhanced by the fact that it can be traded in international capital markets, which is why foreign investors find it attractive.

The PNs are a slap on the face of every citizen who is an investor, because a person who wishes to invest in India has to open a demat/trading account and have a PAN number, and several Know Your Customer (KYC) forms have to be filled up along with proof of address, etc. For the PN investor, the system is totally different; he does not even provide 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 favor ghost investors. The PNs can be traded in the markets and they do not have to be registered with the Sebi.

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