Mumbai: The restrictions placed by markets regulator Securities and Exchange Board of India (Sebi) on participatory notes (PNs) in 2007 and the subsequent Wall Street crisis of 2008 have helped domestic brokerages take business away from their onshore foreign counterparts.
PNs are offshore derivative instruments used by overseas investors and funds not registered in India for investing in Indian stocks.
As overseas funds route their investments into India from offshore PNs to onshore foreign institutional investors (FIIs), domestic brokerages are making the most of the shift.
Graphics by Sandeep Bhatnagar / Mint
While the market has expanded with the rise in the number of registered FIIs since Sebi gave a number of approvals after October 2007, local brokers are increasingly coming into their own as their foreign counterparts lose key employees as well as market share, say fund house executives and brokers.
As many as 567 new funds were registered in the past 20 months to take the total to 1,680.
Overseas investors cannot directly invest in Indian shares unless they are registered with Sebi. Entities who did not want to register with Sebi, or were not allowed by it, used the offshore derivative instruments issued by Sebi-registered FIIs to participate in the Indian equity markets.
This route gained popularity between 2004 and mid-2007 when PNs rose from under 20% of total assets managed by FIIs to at least 55% in June 2007. Such notes accounted for a major chunk of the $17 billion (Rs82,790 crore today) that was invested by FIIs in 2007.
In June 2007, PNs accounted for Rs3.67 trillion, or 55.7% of total FII assets of Rs6.59 trillion. At the end of June, PN assets stood at less than Rs1 trillion of Rs6.29 trillion.
However, the financial crisis of 2008, which saw storied Wall Street firms such as Lehman Brothers Holdings Inc. collapse, has dented the invincibility of foreign firms’ balance sheets. Realizing the counterparty risk in PNs, investors are now moving business onshore and are more open to trading with local firms, say brokers.
Since September, when Lehman Brothers collapsed, the share of PNs slipped below the 20% mark for the first time since March 2004 and has been declining since.
Seth Freeman, chief executive officer (CEO) of EM Capital Management Llc., a San Francisco-based FII, said the real question is whether investors will trade local shares or use PNs as the market continues to recover and FIIs become more active with Indian investing.
“However, many investors are now well aware of counter-party risk of investing in P-notes and if Sebi continues to make it simpler and faster for foreign funds to invest into India, then domestic firms could be major recipients of volume growth from investors shying away from P-notes,” he said.