Sebi stays firm: PNs headed out

Sebi stays firm: PNs headed out

Mumbai: The country’s stock markets regulator will phase out participatory notes (PNs), a kind of opaque investment instrument used by foreign institutional investors (FIIs) to buy Indian securities, ending significant confusion that had roiled the stock markets and was caused by Sebi’s decision to make its intentions public last week.

Several analysts and fund managers said that while the matter was put to rest for now, the Securities and Exchange Board of India, which has since pledged to speed up other ways for such investors to participate in India’s booming markets, could have avoided the turmoil of the past week.

Net foreign portfolio investments so far this year into India are about $17 billion (Rs67,150 crore), well above the full-year record inflow of $10.7 billion in 2005.

Sebi’s move might briefly aid the central bank as it struggles to manage the side-effects of the flows. “This will have a moderating effect on the inflow of capital in the near term," said A. Prasanna at ICICI Securities.

The new regulations restricting issuance of PNs are effective immediately. PNs are issued by FIIs registered in India to unregistered overseas investors. Registered FIIs buy Indian securities and issue the notes based on the underlying asset.

Sebi claims PNs allow foreign investors to enter the market through a backdoor and without registering with Indian authorities, something that would provider the regulator, and others, with a lot more transparency on inflows.

Sebi chairman M. Damodoran said FIIs and their sub-accounts, vehicles set up by registered FIIs to issue PNs, are no longer allowed to issue PNs whose underlying asset is a derivative. Their positions must be wound up over 18 months. However, sub-accounts applying for an FII status could continue business with their application pending.

Sebi imposed a PN issuance limit of 40% of assets under custody. Entities below 40% would be allowed an annual 5% incremental increase capped at 40% and those above 40% had to stop at the level they had reached.

The Sebi chief also said that among 34 PN-issuing entities in India, including some FIIs, all the sub-accounts have sent their letter of intent within the 24-hour deadline that was stipulated on Wednesday for them to register.

Sebi also said issuance of PNs will be limited to entities that are “regulated" in their home countries. This could mean that many unregulated hedge funds that have are invested in the Indian markets cannot buy Indian shares through such PNs.

The regulatory body also announced few new steps that could help improve the accessibility to Indian markets for foreign investors. Unregulated entities such as pension funds, foundations, endowments, university funds, and charitable trusts and societies, will be allowed to register as FIIs.

All the registered FIIs will be granted permanent status, provided they continue to meet Sebi norms. This means that they will not have to re-register every third year though the re-registration fee has to paid. The cap on maximum shareholding by an individual or an entity in a fund has been raised from 10% to 49%. However, the requirement of at least 20 different shareholders still remains.

“We are saying that we are fast-tracking the system of registration," said Damodaran. “What we are doing is to clean up the regulatory environment."

However, some analysts said the new steps to ease entry norms and regulations of FIIs have fallen short of their expectations.

Bobby Parekh, chief executive of Indian corporate law firm BMR & Associates, said that some of these new policies are not that new. “There have been cases before when pension funds and trusts have been granted FII status," he said. “A policy change such as this could have been initiated in a more matured way."

Ahead of Sebi’s formal announcement on Thursday, the Sensex gained 258 points, on expectations of the regulator loosening some of its norms.

Apart from the announcements on PNs, the Sebi board also approved various other proposals, such as a separate bourse for small and medium enterprises (SME) and that all stock exchanges will have to set up surveillance committees chaired by an independent member of their board.

(Devidutta Tripathy and Virendra Verma of Reuters contributed to this story.)