The Securities and Exchange Board of India (SEBI), India’s securities regulator, has ordered Société Générale to stop issuing participatory notes for Indian securities and threatened to withdraw the French bank’s Foreign Institutional Investor (FII) licence after it violated the ‘know your client’ requirements of India’s FII regulations.
Participatory notes (p-notes), also known as offshore derivative instruments (ODIs), allow foreign firms to invest in Indian stocks. They can only be issued by FIIs that have been given special dispensation by SEBI under the condition that the FII reveals the identity of ultimate end-clients.
SEBI’s action centres on p-notes in Indian telecoms company Reliance Communications Limited that SocGen issued to UK-based firm Hythe Securities between January 2006 and January 2008.
Following requests for further information about Hythe from SEBI, it emerged that Hythe was not the end-beneficiary of the p-notes, but that Hythe had issued them onward to an investment company called Opportunite SA, and further to a designation referred to as Pluri Emerging Co PPC Cell E, Pluri Cell E or just Cell E.
Crucially, according to SEBI, SocGen was unaware that Hythe was not the end-client. The regulator said SocGen stated that agreements signed with Hythe allowed the bank to seek information about the end-beneficiary of the p-notes, but when SEBI asked SocGen to produce the beneficiary’s details it was unable to do so, saying that Hythe was unwilling to provide the information to the bank and preferred instead to send it directly to SEBI. The regulatory stressed in the order that it is the FII’s responsibility, not that of the client, to identify and disclose the end-beneficiary of p-notes.
“It is evident that SG has failed to satisfy the basic tenet of ‘know your client’ compliance when it issued ODIs,” read SEBI’s order. “SG was not only unaware of the end beneficial owner but also did not have any mechanism in place to ensure that it can know the end beneficial owner as clearly demonstrated by the email response where it stated that the client was not willing to provide such a response.”
It added that SocGen’s declaration of inability to provide end-user information because of the client’s reluctance to disclose it “makes a mockery of the regulatory requirements put in place by SEBI.”
As a result, SEBI ordered SocGen not to issue or transact any new p-notes until it provides “a true and correct reporting” of its p-note transactions. Furthermore SocGen will be required to demonstrate why “appropriate proceedings” including cancellation of its registration as an FII, should not be initiated.
The SocGen action echoes SEBI’s p-note suspension order to UK-based bank Barclays in December, after the bank erroneously disclosed the end-client of Reliance Communications p-notes as Swiss Bank UBS, before later changing it to Hythe Securities. As with the SocGen case, SEBI later learned that the p-notes had been passed from Hythe to Pluri. However, SEBI stopped short of threatening Barclays with the cancellation of its FII licence.