'Participatory notes will not be banned'

18 Oct, 2007, The Economic Times

MUMBAI: SEBI chairman M Damodaran is of the view that the proposal to bar sub-accounts from issuing participatory notes will help make the system more efficient and transparent.

SEBI will also make changes to FII registration norms so as to encourage more overseas players to come into Indian markets directly rather than through the circuitous route of P-Notes. In an exclusive chat with ET , Mr Damodaran gave insights into the rationale for the proposals made by the regulator on participatory notes.

Will P-notes will be banned?

Not at all. We recognise P-Notes as a legitimate way of investing in the Indian market. At present, there are restrictions on the class of investors which can invest in India. We also recognise the fact that until the Indian economy opens up completely, P-notes will continue to remain. As to those investors who are not investing in the Indian market directly (but through P-notes), we would like to know what the underlying assets are.

Why the immediate ban on sub-accounts issuing P-Notes?

Both FIIs and their sub-accounts are registered with us. Both of them are allowed to issue P-Notes. So, we have two classes of investors that are issuing P-Notes — an FII, who is at the top of the heap, and sub-accounts that have been brought in by the FII.

Sub-accounts were set up with an aim to manage funds of clients that cannot directly invest in India. But FIIs do a lot of proprietary trading themselves (trading on behalf of the firm). And we have found that often FIIs issue P-Notes to themselves through sub-accounts. We have told them that since they fulfill the eligibility criteria, why not register themselves again if need be, and invest directly.

We are comfortable with having more than one FII registration from the same stable. As for the investors who do not fulfill the eligibility criteria, we are asking them to stick to simpler products like either equity or debt, and not derivatives. We are not saying that the system is unclean, but making one contact point for P-Notes makes it cleaner and more efficient.

Why the ban on P-Notes with derivatives as the underlying asset?

Our analysis of P-Notes showed that many entities were excessively leveraged by way of exposure to the derivatives markets. This could add to the pressure in the market in the event of a downtrend. If an entity has an exposure to different stocks through P-notes, he doesn’t necessarily have to sell everything when there is a fall. He can sell some of the stocks that are doing well and hold on to the rest. But if an entity has exposure to only derivatives, what will he sell when the market falls?

Will FII registration norms be eased further?

We are trying to encourage more FIIs to come through the front door by making the registration process faster. In addition, we are looking at the content of disclosures, and whether these can simplified further. We are also looking at investors who have been missed out, and who could be eligible to invest in India directly.

http://economictimes.indiatimes.com/Participatory_notes_will_not_be_banned/articleshow/2468698.cms

With Thanks from the Economic Times

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