Inside Financial Markets

Ghost Investors

Ghost InvestorsA trader works on the floor of the New York Stock Exchange

Participatory Notes commonly known as P-Notes or PNs are instruments used for making investments in the stock market. They are also called offshore derivative instruments as they are used to make investments in one country from the other country. These instruments are used for facilitating the clients who don’t wish to disclose their identity or not interested to participate directly into the stock market. There are two major reasons to make investments through the P-Notes, one is the need for anonymity as the entity or person investing through P-notes is not required to register or open account in a local brokerage house. The other reason could be tax saving as some investors’ route their investment through P-notes to take advantage of the tax laws of certain preferred countries.

The PNs are a clear discrimination with every local investor. For an investor to invest in a single share, he needs to fill out several forms with numerous signatures and signature verification from the bank in which he holds an account. For a P-note investor, the system is completely silent. Since the introduction of Capital Gains Tax, the Karachi Stock Exchange was nearly dead with volumes touching historic lows on back of demand from tax authorities to disclose the source of income. Every alternate month there is a 10 pager circular from the SECP on the KSE website to ensure the curb of money laundering in the stock exchanges but what about the P-notes investors who neither have to disclose the source of income nor has to disclose their identity to the regulators.

The stock exchange has seen a good foreign inflows coming in the markets among which a significant portion is contributed by P-notes investors. In principle, the foreign inflows coming into the stock exchange is a big positive but at the same time, the level playing field should be provided to the local investors. A local investor, invests in the capital markets with a fear of recieving a surpise buzz from tax authorities anytime to disclose his source of income whereas P-notes investor enjoy anonymity. The other risk which the local companies face is those anonymous investors who would like to acquire/control the company by taking them over. Recent example is the ENGRO shareholder who has acquired a significant shareholding in the company without disclosing the identity. This could turn out to be a danger for the domestic companies as the unknown entity/investor may be targetting the company without its knowledge.

P-notes are also a disadvantage for the local brokerage houses and custodians as few foreign financial institutions are enjoying the market share charging high commission amounts and custodial fees. Local brokerage houses and custodians who are already striving for the volumes are witnessing big investors deactivating their local accounts and routing their volumes through the P-notes into the local markets.

It is worth noting that the governments and tax authorities have been employing all their efforts to increase the tax base of the country. The recent move was to tax the capital gains on the capital market which is indeed a good move but no investor should be discriminated. The regulator must ensure that whether the investor is small or big, local or foreign all are taxed and the regulator should be aware of their identity. Similar KYC measures should be adopted for each and every investor irrespective of local or foreign. Being one of the best markets in terms of attractive valuations, we should have confidence on our capital market and realise that we can get foreign inflows with proper identities.

Ali Nawaz

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Inside Financial Markets was a joint publication of Pakistan Stock Exchange (PSX)and Society of Technical Analysts Pakistan (STAP)