Mumbai: Foreign institutional investors (FIIs), the main force behind the doubling of India’s benchmark equity index this year, are favouring so-called sub-accounts to fund stock purchases, shunning participatory notes (PNs), restrictions on which were lifted a year ago.
Capital market regulator Securities and Exchange Board of India (Sebi) had banned PNs in October 2007, amid concerns about volatile foreign exchange inflows that were fuelling the creation of an asset bubble. A year later, the credit freeze forced the regulator to lift the ban as part of the efforts to revive the equity markets.
Graphics: Sandeep Bhatnagar / Mint
Overseas investors are staying away from PNs to keep on the right side of the regulator, say some legal experts.
“Foreign investors now prefer to park their funds through the sub-account route even though they are allowed to come through PNs. This is because there is an uncertainty whether Sebi will continue to allow FIIs to issue PNs or not,” said Kishore Joshi of Nishith Desai Associates, a Mumbai-based legal and tax counselling firm.
Merrill Lynch and Co. Inc. (now Bank of America Merrill Lynch), Morgan Stanley, Credit Lyonnais SA, Citigroup Inc., Goldman Sachs and Deutsche Bank AG were the biggest issuers of PNs when the Indian market was in the midst of a bull run that began in 2004. They charged clients stiff commissions, often exceeding 85 basis points, while direct trades can be executed for 25 basis points or even less.
One basis point is one-hundredth of a percentage point.
A sub-account, an actively managed investment book, is run in the name of registered FIIs, but managed by separate fund managers.
PNs are derivatives used by foreign funds not registered in India to trade locally while the actual investors remain anonymous. The derivatives permit holders, some of whom may not be eligible to trade in the Indian stock markets, to benefit from the value of the underlying security.
While Sebi removed curbs on such derivatives after a year, it tightened know your customer norms for FIIs issuing the instruments and asked them to report details about the assets under PNs every month.
According to experts, these stringent disclosure norms have persuaded investors to adopt the sub-account route. where registration is relatively easier.
In the past two years, 1,878 entities have registered with Sebi, taking the total to an all-time high of 5,268 on 1 October, a 55% increase over last year. FII registrations have also seen a similar spike, rising from 1,219 to 1,699 between 2007 and 2009.
In contrast, from the peak of 55.7% in June 2007, PNs account for 15% of total assets managed by FIIs in August 2009. This has remained unchanged since January despite an inflow of $12.13 billion (Rs57,618 crore today). In 2007, FIIs pumped a record $17.65 billion into Indian equities.