Regulations
Double Standards over Black Money
While Indians will face the consequences of a draconian law, ‘foreign money’ gets to hide as faceless Participatory Notes
 
In 2007, Prof R Vaidyanathan (of IIM Bengaluru) wrote in The Hindu Business Line that Participatory Notes (PNs) had “created a storm in the stock market, with SEBI (Securities and Exchange Board of India) coming out with a draft for discussion on how to regulate them, the Reserve Bank of India (RBI) suggesting that they be phased out, and the finance minister assuring that the government is not going to phase them out.” 
 
Prof Vaidyanathan, who is working on a book on Black Money & Tax Havens and India’s Wealth Abroad—and is a member of several committees of the capital market regulator—has been strongly in favour of phasing out these faceless investment instruments.
 
PNs are offshore derivative instruments issued by foreign institutional investors (FIIs) or their associates against underlying Indian securities. They are issued to investors who are either not qualified to invest in the Indian market or not registered with the regulators. By their very nature, PNs camouflage the beneficial ownership and the fact that they are quickly and easily transferable makes it almost impossible to track true ownership. 
 
Eight years after Prof Vaidyanathan’s article was published, it was déjà vu again. At the end of July 2015, a Supreme Court-monitored special investigation team (SIT) on black money caused another flutter by asking the capital market regulator to put in place regulation to pinpoint ‘final beneficial owners’ of PNs, right down to the individuals, or promoters and directors of companies that held the PNs.  
 
This was just a part of a slew of instructions to the market regulator to step up action and prosecution against those who use equity investment to manipulate prices and evade taxes. The SIT noted that SEBI has an effective market monitoring mechanism that can red-flag unusual market movement both in terms of price and trading volumes. It asked that this information should be shared with the tax authorities as well as the Financial Intelligence Unit (FIU) in the finance ministry. A part of these instructions was to ensure better transparency in FII investment through PNs with a serious attempt to track beneficial ownership.
 
Predictably, the SIT report led to sharp dip in stock prices. Immediately, in a replay of 2007, the SEBI chairman, UK Sinha, rushed to clarify that “neither the Special Investigation Team (SIT) on black money nor the government has suggested closing the P-Note route and it was a business requirement for a certain class of foreign investors.” If that were not enough, the finance ministry also rushed into needless damage control and assured investors that there will be no hasty decision on PNs based on the SIT report. Was this necessary? 
 
A lot has changed in the developed world since 2007. There is a serious crackdown on tax evasion as well as market manipulation. But things remain absolutely the same in India, as far as foreign portfolio investment is concerned. We have the finance minister rushing out to appease foreign investors at the first sign of market turmoil. And, we continue to have bankers and lawyers making the same tired arguments about how large foreign funds would not invest in India if they were asked to be transparent about beneficial ownership. 
 
In fact, all the evidence points to the contrary. Speaking at a Moneylife Foundation event on 29th July, Prof Vaidyanathan pointed out that increased longevity in the developed world has meant that giant pension funds are under pressure to locate markets, like India, which give them a return of over 4% after factoring in various risks. 
 
Consequently, clean institutional money is more likely to fall in line with domestic regulations, since they have nothing to hide. This is already happening. In 2007, nearly half the portfolio investment into India was from non-transparent PNs. Today, PNs are estimated to account for merely 11.5% of the total assets held by foreign portfolio investors. This would mean that institutional investors, convinced about the India story, probably, have their core holding through direct investments. The gradual tightening of disclosure rules over the past years would also have nudged them to register with SEBI. 
 
Instead of rushing to reassure FIIs that PNs will be allowed to continue, the finance minister ought to have announced a deadline for phasing out these non-transparent investments or to force full disclosure of beneficial ownership.
 
Prof Vaidyanathan correctly says that PNs are ‘a slap on the face of every citizen who is an investor’ who has to comply with tedious know your customer (KYC) requirements to buy even a single share. But a foreign investor can invest millions of dollars though faceless PNs. These double standards become even more of an insult in the context of the draconian Black Money (Undisclosed Foreign Income and Assets) and Imposition of Tax Act, 2015 that has been passed by the Bharatiya Janata Party (BJP)-led government. 
 
The Act specifically focuses on ‘undisclosed foreign income and assets’ which cover everything—from immovable property to jewellery, bullion, shares (including ESOPs), archaeological collections and artwork. The government has also notified the rules for calculating overseas income and assets and has given people a small window until 30th September, to declare such assets and pay up a penalty, if they wish to avoid proceedings under the Act. 
 
Does this mean that the Act will only harass Indians who are not wealthy enough to route their funds through layers of numbered accounts and international banks? And, that it will assume that all foreign portfolio investment is clean and opts only for the PN route for ease of transaction? 
 
This would suggest that our government is hypocritical in ignoring the massive crackdown by the United States on the biggest names in global banking. The Wall Street Journal writes that “the biggest global banks have paid more than $60 billion in penalties over the past two years to resolve allegations of wrongdoing.”
 
Additionally, Germany, France, Australia and Britain as well as the G-20 countries have taken stringent measures to crackdown on tax havens. In 2009, the US Internal Revenue Service (IRS) and the Department of Justice (DOJ) broke through the famed Swiss bank secrecy laws. UBS, a top Swiss bank, revealed the names of account-holders in an issue that remains controversial with new disclosures about the Bank’s contributions to the Clinton Foundation. In 2014, Citigroup negotiated a $7-billion settlement with the US DOJ over dubious mortgage securities transactions. JP Morgan Chase had earlier entered a $13-billion settlement and Bank of America has since paid up almost $17 billion after pleading guilty to a series of violations. 
 
Elsewhere, Deutsche Bank, the largest German Bank, has coughed up $2.5 billion in penalties after admitting to rigging the London Inter-Bank Offered Rates (LIBOR). In the US, five big banks have paid up $5.6 billion after pleading guilty to criminal charges for manipulating the foreign currency markets. These include Barclays, UBS, Royal Bank of Scotland, Citigroup and JP Morgan Chase. 
 
Is our government naïve enough to believe that non-transparent PNs are only being used as a business necessity by large portfolio investors? Or are our political leaders continuing to protect the super-rich who are behind the round-tripping of funds through the capital market? 
 
According to Prof Vaidyanathan, unaccounted Indian money abroad is anywhere between $500 billion to $1.5 trillion. This is not going to come back, if the government dithers over uniform applicability and strict enforcement of the black money legislation.
 

User

COMMENTS

LALIT SHAH

1 year ago

Face less so called FII is oxygen of Indian Stock Market. If band crash bigger than 2008 will there.
This govt.is other side of same coin.
A chaiwala got chance to enjoy world tour of 190 country's where before no body gone.and live like a Sultan a hind.
So many durbari like vanky soughting ba mulaija hoshiyar " Savdhan taqdire hind /shehnshahe ea hind modiji padhar rahe hey / mahamaga (shushma) tasriff la rahi hey.
BAHOT khub murkh banaya Hindustan ke hinduo KO humderd hone KA natak karke
Wah MODI Sarkar wah

Ankur Bhatnagar

1 year ago

Whichever issue one picks up, one will invariably reach corruption as its root cause.

"Is our government naïve enough to believe that non-transparent PNs are only being used as a business necessity by large portfolio investors? Or are our political leaders continuing to protect the super-rich who are behind the round-tripping of funds through the capital market?"

My guess is that our government is not naive. (How do you type that i with two dots?)

REPLY

Kalpesh Shah

In Reply to Ankur Bhatnagar 1 year ago

I think "naive" is fine as English doesnt have i with 2 dots. :)

Krishnan

1 year ago

I recall the former learned Governor of RBI passionately demanded withdrawal of P Notes. His demand fell on deaf years. I hope Modi will take courage to dismantle the P Note regime overruling the FM, SEBI and others.

mathai

1 year ago

the most outstanding failure of modi govt is in the black money case. (that modi govt pulled off many scintillating victories is a reassuring fact.) first it was the 90 days target to bring back all that is black . now this face saving legislation.( which is draconian is another funny twist.)

the unbroken support to rigging of the share market thru what is called PN . and the struggle to justify its continued use.

bearable till the share market bubble bursts tomorrow which is any day from today. it is better to keep an excuse ready for that day. to cover up the dismal regulatory failure , if not intentional manipulation, of the stock market

Vishal Modi

1 year ago

When do domestic tax payers get some dignity and fair treatment vis a vis foreigners from our babus?

RH_9669

1 year ago

India's rulers have always made laws with loop holes for the benefit of themselves, their cronies, and the "permanent" or tenured Kleptocrats. Nehru said it best in the Constituent Assembly to justify inequality under law, exceptions to the rule of law and the "Many Nations Theory": "Show me the person and I shall show you the law". It would be misleading to say that double standards or hypocrisy is the leit motif of the Indian Republic. This is but a means to an end. The application of the nation's resources to the personal pelf, pomp, pleasure, perversions and perpetuation of the Politician-Bureaucrat-Police-Judiciary-Crony-Preferred Caste/Tribe/Religion. If one reads the fine print of India's Constitution and laws, India, where even the right to contest elections is gerrymandered by law, is not a democracy, a sovereign state, a secular state or even a state that values equity, justice and human life.

REPLY

webkitendfullscreen

In Reply to RH_9669 1 year ago

You want to curb black money? Just curb the stamp duty to half of what it is. Black money will be curbed to a large extent. Land reforms will be the way to curb this menace. You can't stop hawala to private banking accounts in Switzerland or Singapore. Cash deposits ban in these countries will not happen because of Indian black money problems.

webkitendfullscreen

1 year ago

P Notes are the only legitimate way for white people and Chinese investors to invest. We can buy shares in Apple. Can Americans buy shares in Hindustan Lever? P Notes are omnibus accounts which allow investors to bypass the draconian KYC regulation in India. You can ban P Notes, no problem. Atleast correct the problem of the ban on foreign individuals and corporations investing directly into the stock market. If you ban P notes the FII shareholding of corporations will vanish overnight. If that is what you wish then you should. Furthermore this is an ass backwards concept of tackling black money. Black money is actively created through real estate where the stamp duty is deliberately kept high and a ready reckoned suggested rate is published by the government. That ready reckoner is a official black money guide published by the Government. The black money menace should be tackled at the creation level, not when it has been whitewashed and invested through the financial system. If India's approached on black money tackling worked, the Americans would create P notes as well and ban foreigners from investing directly.


Naresh Nayak
Melbourne, Australia

Suketu Shah

1 year ago

Great article.This is why India needs Dr Swamy more than ever involved at the top in finance ministry.He understands India economics inside out and most importantly has honest intentions towards the country.

Deepak B Sholapurkar

1 year ago

indian Blank money is not in swissbanks but its in Indian stock market and in indian real estate. Just bank PNotes and see how much market corrects

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