P-Notes clampdown

The Securities and Exchange Board of India (Sebi) today proposed to tighten the rules for purchase of shares and bonds in Indian companies through the participatory note (PN) route.

The move is aimed at arresting the surge in foreign inflows through PNs, which are offshore derivative instruments that allow foreign investors to invest indirectly in a country's stock market, which has seen the benchmark BSE Sensex zoom more than 5,000 points in two months.

The market regulator has proposed that foreign institutional investors (FIIs) and their sub-accounts cannot issue or renew PNs with underlying as derivatives with immediate effect. They have to unwind their current position within 18 months.

Sebi Chairman M Damodaran told Business Standard that the proposals were against PNs but not against FIIs. The procedures for registering FIIs were in fact being simplified, he said.

Sebi has also proposed a ban on all PN issuances by sub-accounts of FIIs with immediate effect. They also will be required to wind up the current position over 18 months, during which period the capital markets regulator will review the position from time to time.

Sebi has also proposed an incremental rate of 5 per cent for issue of PNs for FIIs with less than 40 per cent of assets in PNs. Those with over 40 per cent of assets in PNs can issue PNs only against redemptions or cancellations.

PNs are issued by Sebi-registered FIIs that do not want to disclose their identity, or those who are in a rush to buy stocks and derivatives without waiting for Sebi registration.

The proposals, which have been framed in consultation with the government, will be "implemented urgently", after receiving comments from market participants within four days. The Sebi board is meeting on October 25 to take a final decision.

The big five FIIs — Morgan Stanley, Merrill Lynch Capital Markets Espana, Citigroup Global Markets, Goldman Sachs and CLSA Merchant Bankers — account for 60 per cent of PNs issued in India.

The Sebi release, issued late this evening said, "The year-on-year increase in PNs, the anonymity that they provide to investors and the copious inflows into the country from foreign investors have been engaging the attention of the government."

"There is an unprecedented surge of liquidity in the emerging markets. And apart from Brazil, the Indian equity markets are favoured the most by foreign institutional investors. However, it would be too premature to make any judgments now," said head of Korean mutual fund Mirae Asset Management Arindam Ghosh.

Market expects huge selloff; ADRs dip

The proposed restrictions on participatory notes (PNs) are expected to trigger a sell-off by hedge funds, and other short-term players, experts said. As a result, the Sensex, which has risen nearly 35 per cent in the last two months, may also feel the heat when the markets open on Wednesday morning.

Indications from the kerb (unofficial deals) and the fall in Indian share prices in the US markets suggest that the NSE's Nifty Index may open at a discount of at least 150 points from today's closing of 5,668.05, said dealers.

At 9.45 pm, Dr Reddy's Lab ADR was down 5 per cent to $15.25, HDFC Bank was down 6 per cent to $111.34, ICICI Bank nearly 4 per cent to $53.32 and Infosys was down 5.8 per cent to $48.02.

Hedge funds, which account for at least 30 per cent of PN issuance, may be the first ones to exit, said dealers.

When restrictions were proposed on PNs on January 22, 2004, the Nifty closed 3 per cent lower to 1,770.

Former NSE Chairman R H Patil said, "The market is being manipulated right now and a bubble was growing rapidly. Although the Sebi proposals are late, they would help avoid a greater disaster. It is very important to know the identity of foreign investors, who have been manipulating this market."

Chidu was warning all of us that he was going short on the market 2-3 days ? How many of you did ?