The International Financial Services Centres Authority (IFSCA) is considering the possibility of permitting alternative investment funds (AIFs) to issue offshore derivative instruments (ODIs) or participatory notes (P-notes) from the GIFT IFSC, reported Business Line.
The P-notes enable foreign investors to gain indirect exposure to Indian securities without the requirement of registering with the nation's market regulatory body. The current year's budget officially acknowledged ODIs as a legitimate contract, provided they are issued by offshore banking units that are registered as foreign portfolio investors (FPIs) within IFSC.
A task force has been established to evaluate the feasibility of extending this to AIFs. This expansion would diversify the market for P-note issuers, which is currently largely controlled by foreign banks, and experts believe it would lead to improved pricing and increased accessibility. There are presently 63 AIFs registered within the IFSC, although not all of them hold the status of FPIs.
The success or failure of financial innovations hinges significantly on the regulatory framework. IFSCA, by actively adjusting to the evolving requirements of the market, has the potential to establish a precedent for the way financial hubs transform to better cater to both local and global investors. Although the possibility of AIFs being permitted to issue P-notes remains uncertain, such a move could enhance the attractiveness of IFSC to a wide range of investors.
How the process operates
Modifications to regulations will be necessary to permit AIFs to oversee a segregated portfolio.
In contrast, prime brokers, subsidiaries of foreign banks, generally engage in individual agreements with investors seeking to invest in P-notes. AIFs, on the other hand, are unable to enter into such agreements. This is due to the fact that these funds function as pooled vehicles, with returns connected to units assigned a shared net asset value.
Ongoing deliberations are in progress with IFSCA and other regulatory bodies to authorize AIFs to issue ODIs. Nevertheless, there will be hurdles to overcome, such as the need to carefully consider portfolio segregation.
The current tax exemption applies to the transfer of P-notes or distributions from an offshore banking unit at an IFSC to a foreign investor. A comparable provision will need to be extended to AIFs as well.
The P-notes were initially issued with cash equities, debt, or derivatives as their underlying assets. However, in 2018, the market regulator prohibited FPIs from issuing P-notes with derivatives as the underlying assets, except when used for hedging purposes.
During its heyday, P-note issuances constituted approximately 7-8 per cent of the total FPI assets under custody. Since the ban, this figure has dwindled to approximately 2 per cent.