The third report of the Supreme Court-appointed Special Investigation Team (SIT) on black money has rightly focused on the role that the stock market plays in converting unaccounted black money into accounted money. It has especially focused on the role of ‘round tripping’ of unaccounted funds via participatory notes (P-notes) issued to offshore investors, as well as market manipulations by domestic entities. While the issue of promoters and market intermediaries aiding money laundering by rigging up stock prices of companies with no fundamental value is a genuine concern and needs to be addressed speedily, the role of P-notes in abetting round-tripping has reduced considerably over the years. While P-notes — derivative instruments, with underlying Indian stocks, debt or derivatives, and issued by foreign portfolio investors to entities outside the country — are admittedly one of the conduits used for round-tripping domestically generated unaccounted money via overseas tax havens, tighter regulation has reduced the gravity of the threat they pose. P-notes were a threat in 2008, when they accounted for over 50 per cent of the assets of foreign investors; now they form just 11 per cent of these assets. Due to heightened regulatory scrutiny and the ever-present threat of the regulator banning the issue of these instruments, users of this route have migrated to other channels. Also, P-note investors are no longer strictly anonymous. Under current regulations, P-notes can be issued only to entities that are regulated in their country and those that have undergone know-your-client checks. However, the suggestion of the SIT committee that P-notes should be made non-transferable is a good one that SEBI needs to adopt, to further sanitise this route.
The markets regulator, therefore, needs to turn its attention to the numerous small companies with unscrupulous promoters and dubious business models that populate the Indian stock market. The BSE has the largest number of companies listed on it — 5,576 companies — according to the World Federation of Exchanges. This is twice the number listed on the NYSE. The market capitalisation of BSE is, however, $1.5 trillion against NYSE’s $19 trillion. These companies have largely proliferated due to the lax regulations governing primary market listings in the years prior to 2010. While tightening of IPO guidelines in recent years will ensure that such companies do not raise money from the public in the future, the regulator will have to devise a way to check malpractices by companies that are already listed.
One way to do that is, as the SIT report has suggested, to make the punishment in such instances more severe. SEBI had mostly stopped with barring entities found guilty of malpractices from the stock market. The SIT report has asked SEBI to share information on such activities with both the tax authorities and the financial intelligence unit. The market regulator has also been asked to launch prosecution under the SEBI Act, which can lead to imprisonment up to 10 years or fine up to ₹25 crore. Along with more stringent punitive action, speedier investigation and trial will also serve as a deterrent.