SEBI Plans Curbs On FII Participatory Notes

Mumbai: Market regulator SEBI on Tuesday proposed restrictions on the issue of participatory notes by Foreign Institutional Investors, in an apparent bid to stem the unceasing inflows into the booming Indian stock market.

In a surprise development SEBI, late in the day, issued a discussion paper suggesting an immediate ban on issue of PNs by FIIs against underlying derivatives (futures and options on shares) while also restricting issue of PNs in the cash segment.

The proposed move assumes significance, as the PN issue over which there has been a tug-of-war between the RBI and the Finance Ministry for some time now.

“We think Reddy has prevailed over the Finance Ministry which has been vetoeing such a move again and again,” said the head of a stock market research firm.

“FIIs and their sub-accounts shall not issue/renew Offshore Derivative Instruments (ODIs) with underlying as derivatives with immediate effect,” said SEBI’s discussion paper.

“They are required to wind up their current position over 18 months, during which period SEBI will review the position from time to time,” it said.

Notional value

Currently there are 34 FIIs/sub-accounts issuing ODIs. The notional value of PNs outstanding grew to Rs. 3,53,484 crore by August, 2007, constituting 51.6 per cent of Assets Under Custody (of all FIIs/sub-accounts).

The value of outstanding ODIs with underlying as derivatives stands at Rs 1,17,071 crore currently, approximately 30 per cent of total PNs outstanding. The notional value of outstanding PNs, excluding derivatives as underlying, is 34.5 per cent of AUC.

In the cash market, SEBI has proposed that FIIs who are currently issuing ODIs with notional value of PNs outstanding (excluding derivatives) of less than 40 per cent of their AUC shall be allowed to issue further ODIs only at the incremental rate of 5 per cent of their AUC in India.

“Those with notional value of PNs outstanding (excluding derivatives) of more than 40 per cent of AUC shall issue PNs only against cancellation/ redemption/ closing out of existing PNs of at least equivalent amount,” said SEBI.

“If you are an investor, you will not get affected by this, whether you are Indian or foreign,” said Arun Kejriwal, who heads Kejriwal Research & Information Services. “But if you have dubious credentials, then it will affect you. Ultimately it will weed out such players and create a healthier market.”

Kejriwal also held that the time frame of 18 months is too little. “They should be made to wind down positions by 25 per cent every three months, and get down to zero in 12 months,” he said.

The market will react negatively in the short term, he said. “If the market is going up by 500-600 points a day, then anything less than a 1000 point fall will not be a crash,” he said.