P-Notes.doc

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A Securities and Exchange Board of India proposal to tighten the rules for purchase of shares and bonds in Indiancompanies through the participatory note route took the breath away of the Indian stock market and it suffered itsbiggest fall in history.

So what are these participatory notes? And why do they have this huge impact on the Indian securities markets?

P-Notes

articipatory !otes "" or "!otes or !s "" are instruments issued by registered foreign institutional investors tooverseas investors# who wish to invest in the Indian stock markets without registering themselves with the marketregulator# the Securities and Exchange Board of India.

$inancial instruments used by hedge funds that are not registered with Sebi to invest in Indian securities. Indian"based brokerages to buy India"based securities % stocks and then issue participatory notes to foreign investors. Anydividends or capital gains collected from the underlying securities go back to the investors.

Why P-Notes?

Since international access to the Indian capital market is limited to $IIs. &he market has found a way to circumventthis by creating the device called participatory notes# which are said to account for half the '() billion that stands tothe credit of $IIs. Investing through "!otes is very simple and hence very popular.

What are hedge funds?

*edge funds# which invest through participatory notes# borrow money cheaply from +estern markets and investthese funds into stocks in emerging markets. &his gives them double benefit, a chance to make a killing in a stockmarket where stocks are on the rise- and a chance to make the most of the rising value of the local currency.

Who gets P-Notes?

"!otes are issued to the real investors on the basis of stocks purchased by the $II. &he registered $II looks after allthe transactions# which appear as proprietary trades in its books. It is not obligatory for the $IIs to disclose their clientdetails to the Sebi# unless asked specifically.

What is an FII?

An $II# or a foreign institutional investor# is an entity established to make investments in India.

*owever# these $IIs need to get registered with the Securities and Exchange Board of India. Entities or funds that areeligible to get registered as $II include pension funds- mutual funds- insurance companies % reinsurance companies-investment trusts- banks- international or multilateral organisation or an agency thereof or a foreign governmentagency or a foreign central bank- university funds- endowments serving broader social ob/ectives0- foundations

serving broader social ob/ectives0- and charitable trusts % charitable societies.

&he following entities proposing to invest on behalf of broad based funds# are also eligible to be registered as $IIs,

• Asset 1anagement 2ompanies• Investment 1anager%Advisor

http://www.rediff.com/money/2007/oct/17mkt2.htmhttp://www.rediff.com/money/2007/oct/17mkt2.htm


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• Institutional ortfolio 1anagers

• &rustees

How does Sebi regulate FIIs?

$IIs who issue%renew%cancel%redeem "!otes# are re3uired to report on a monthly basis. &he report should reach theSebi by the 4th day of the following month.

&he $II merely investing%subscribing in%to the articipatory !otes "" or any such type of instruments%securities "" withunderlying Indian market securities are re3uired to report on 3uarterly basis 5an"1ar# Apr"5un# 5ul"Sep and 6ct"7ec0.

$IIs who do not issue !s but have trades%holds Indian securities during the reporting 3uarter 5an"1ar# Apr"5un# 5ul"Sep and 6ct"7ec0 re3uire to submit 8!il8 undertaking on a 3uarterly basis.

$IIs who do not issue !s and do not have trades% holdings in Indian securities during the reporting 3uarter. 5an"1ar# Apr"5un# 5ul"Sep and 6ct"7ec0, !o reports re3uired for that reporting 3uarter.

Who can invest in P-Notes?

a0 Any entity incorporated in a /urisdiction that re3uires filing of constitutional and%or other documents with a registrarof companies or comparable regulatory agency or body under the applicable companies legislation in that /urisdiction-

b0 Any entity that is regulated# authorised or supervised by a central bank# such as the Bank of England# the $ederal9eserve# the *ong :ong 1onetary Authority# the 1onetary Authority of Singapore or any other similar body providedthat the entity must not only be authorised but also be regulated by the aforesaid regulatory bodies-

c0 Any entity that is regulated# authorised or supervised by a securities or futures commission# such as the $inancialServices Authority ;:0# the Securities and Exchange 2ommission# the 2ommodities $utures &rading 2ommission#

the Securities and $utures 2ommission *ong :ong or &aiwan0# Australian Securities and Investments 2ommissionAustralia0 or other securities or futures authority or commission in any country # state or territory-

d0 Any entity that is a member of securities or futures exchanges such as the !ew


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*edge funds were largely blamed for the sudden sharp falls in indices. ;nlike $IIs# hedge funds are not directlyregistered with Sebi# but they can operate through sub"accounts with $IIs. &hese funds are also said to operatethrough the issuance of participatory notes.

3 ! FII "oney in stoc#s thru P-Notes

According to one estimate# more than ) per cent of foreign institutional money coming into India is from hedgefunds. &his has led Sebi to keep a close watch on $II transactions# and especially hedge funds.

*edge funds# which thrive on arbitrage opportunities# rarely hold a stock for a long time.

+ith a view to monitoring investments through participatory notes# Sebi had decided that $IIs must report details ofthese instruments along with the names of their holders.

Sebi 2hairman 1 7amodaran has said that the proposals were against !s but not against $IIs. &he procedures forregistering $IIs were in fact being simplified# he said.

Sebi has also proposed a ban on all ! issuances by sub"accounts of $IIs with immediate effect. &hey also will bere3uired to wind up the current position over @( months# during which period the capital markets regulator will reviewthe position from time to time.

Sebi chairman 1 7amodaran# in a recent interview Business Standard # said that the amount of foreign investmentcoming in through participatory notes keeps changing and is somewhere between " ) per cent. C9ecent indicationsare that it has gone up a little but again after the sub"prime crisis# there have been some exits. But it8s a fairlysignificant percentage# it8s not something you can ignore.C

+hen asked if he was comfortable with almost one"fourth of the market being held by "!otes# he said that hewasn8t 8entirely uncomfortable.8

Documents

P-Notes.doc