P-Notes on the rise with market surge

May 29 There are signs that issue of Participatory Notes by foreign institutional investors has been increasing the last six months and has gathered momentum in the current market rally, say market experts.

“Yes we have noticed an increase in P-Notes subscription,” said Mr Kishore Joshi of Nishith Desai Associates, a law firm that provides international legal counselling services.

“Part of the reason is that, first, SEBI’s reinstatement of its original policy on P-notes in August 2008 (reversing its 2007 restrictions on P-notes) lent further legitimacy to P-Notes, and, second, they offer an easier and hassle free means of trading in the Indian market when the short-term sustainability of the market is unclear and, finally, P-Notes may offer easier means of leverage.”

In fact some of the SEBI-registered sub-accounts of FIIs have themselves been investing through P-Notes in the last two months, said a senior official at another legal firm. This is because in the current global downturn, they may be compelled to move their funds out fast if necessary, and it is convenient to invest abroad (through P-Notes) instead of bringing funds into and out of India, he said.

P-Notes are derivative instruments (with underlying Indian securities) issued by FIIs to overseas investors of undisclosed identity and who are not registered with SEBI. P-Notes have often been under attack for their potential to function as an easy conduit for “hot money” inflows.

Some market participants said the return of the UPA government could have also given a fillip to P-Notes, since the political parties (the Left, the BJP and AIADMK) who had expressed reservations about P-Notes are out of the reckoning now. (The outgoing Congress-led government had filed a Supreme Court affidavit early this month saying that P-Notes are in the larger economic interests of the country.)

FIIs have net invested more than $3 billion in India in 2009 so far. There are no available statistics on how much of this involves P-notes as SEBI —– the only entity that can collate the information – does not make public such data, which many market players feel it should. However, data provided by SEBI on securities lent by FIIs abroad indicates that 35 FIIs are issuing P-Notes.

“It is in the larger interests of the market and indicates the Indian markets’ vulnerability to global events,” said a market expert. “As long as P-Notes are available, people who are not registered as sub accounts or FIIs will use them to participate in the market rally,” said Mr Vinay Mehta, Managing Director of Almondz Global, which does institutional broking.

But whether SEBI can successfully summon detailed data is itself questionable, said legal experts. The Securities and Appellate Tribunal overturning a SEBI order on UBS Securities Asia, had remarked that the latter was not required to provide SEBI details of top investors to whom derivative instruments had been issued since this was not provided for in the FII regulations.

In another case, SAT had said that Goldman Sachs was not required to furnish an undertaking that they had not issued ODIs to Indians or to Overseas Corporate Bodies, since there was no bar on such deals in the regulations.

Some market experts say there is little reason for P-Notes to be as popular as they once were. Ms Dina Mehta, Managing Director of Asit C Mehta, says that P-Note investors are those who are in a hurry and that is not the scenario currently. “I think we will see more genuine, regulated investors with a long-term view coming in.”