The India Street Analysis
What are (Participatory Notes) P-Notes?
P-Notes are financial instruments or contracts that are issued by FII’s to investors and hedge funds who wish to invest in India stock markets, but who are not registered with SEBI (Securities and Exchange Board of India).
This is similar to American Depository Receipt; Though the US investor buys the Indian stock by paying US dollars, he never gets the stock credited into his demat account. Instead it remains as depository share, which can be traded like a stock.
How are P-Notes regulated?
According to the statistics available at the SEBI web site, there are 109 registered FII’s as on today, of which 34 Issue P-Notes. FII’s who issue/renew/cancel/redeem P-Notes need to report details about the P-Notes on a monthly basis not later than 7 th of the following month. FII’s investing/subscribing to the P-Notes -- are required to report on quarterly basis.
SEBI has given some guidelines as to who can invest in P-Notes:
- Company incorporated according to the local laws in the country of registration
- Financial institution, such as bank which is monitored by a central bank
- Securities or futures commission
- Member of a recognized stock exchange
According to SEBI Chairman M Damodaran, 25 to 30 per cent of the foreign investment is through issuance of participatory notes.
Proposal by SEBI:
On October 16, the SEBI made a proposal to tighten the regulations for P-Notes. On October 17, trading at the Indian stock markets were halted few minutes after opening as the Nifty plunged to hit the 10% lower circuit limit. This was only the third time trading was halted for one hour in the last 3 years. After resumption, the Nifty gradually recovered from the day’s low and closed at 5559, losing about 1.92%. For those who are interested in candlestick patterns, a “hammer” was formed today at the top of an uptrend.
The Finance Minister, Palaniappan Chidambaram clarified on television channels that SEBI would attempt to moderate foreign fund inflows. The SEBI Chairman said later that “the proposal to bar sub-accounts from issuing participatory notes will help make the system more efficient and transparent.” He was also of the opinion that if an entity has exposure in stocks, the pressure on the market would be less in the event of a downtrend since stocks need not necessarily be sold; but exposure in derivatives, with stocks or indices as underlying assets would be critical in case the market falls, more selling may take place to minimize the losses.
Business Standard has reported that HDFC has the highest P-Notes holding (14.2 per cent) followed by ICICI Bank (9.1 per cent).
The P-Notes will not be banned, however. The FII’s do some proprietary trading and they issue the P-Notes within themselves. By moderating the P-Notes, FII’s will be required to register with SEBI so that their underlying assets can be estimated.
Are the P-Notes being discussed for the first time?
No. The SEBI investigated P-Notes in 2001 stock scam and based on the recommendations of a joint parliamentary committee on the stocks scam, the government banned few overseas corporate bodies from operating in the primary and secondary markets.
In 2003, a technical committee with representatives from SEBI, Reserve Bank of India and Finance Ministry was set up to look into the P-Notes issue.
The Hindu Businessline reported in 2005 that the RBI was concerned about the FII fund inflow through P-Notes.
Is this really a crisis to Indian stock markets?
No. FII money is certainly needed for the Indian stock markets. Without FII’s one could not have thought about the Sensex reaching 19000. With more FII’s certainly the indices are poised to reach higher levels.
However, the regulators’ concern about the genuiness of such inflows is certainly a valid one. SEBI has all the interest and authority to add, amend or modify regulations to the investing and trading procedures at Indian stock markets. So, their action too, should be welcomed, since this will protect the interests of the investors.
Where does the Indian retail investor stand?
The Finance Minister said, “Do your homework or trust someone who can do it for you”. In a market that has been rallying non-stop, definitely retail investors are at a risk since their money is hard earned and they don’t possess the flexibility the FII’s have.
We have mentioned in our weekly and monthly reviews that the market appears to violate the technicals and hence the investors need to be cautious. Though the P-Notes issue is an old one, the market has overreacted to it.