The Hindu Business Line : PN most preferred route for FII investments

Foreign portfolio investments through participatory notes (PNs) are on the increase. Investments through the PN route now account for more than 52 per cent of the total outstanding FII investments against 40 per cent a year ago.

This means beneficiaries to more than half of the $45-billion FII investments in the country's stock markets are unknown entities. The origin of these investments and the credentials of the investors are anybody's guess, according to SEBI sources.

PNs are instruments similar to contract notes issued by registered FIIs in India to their overseas clients who are not eligible to invest directly in the Indian capital market.

The instruments are issued against underlying securities and the holder will benefit from appreciation of capital or income from these securities.

FII investments in the Indian markets have been steadily increasing in the past few years. The net FII investments in this calendar year up to April 3 stood at $4.225 billion and the total flows in 2005 exceeded $10.7 billion.

RBI, SEBI concern

The Reserve Bank of India and the SEBI are increasingly concerned about the increasing fund flows into the bourses from unknown sources.

In fact, in its order against UBS Securities last year, the SEBI had highlighted the risk in allowing FII investments through the PN route.

"The findings in this case have highlighted serious regulatory concerns that the participatory notes or offshore derivative instruments and its cover of anonymity is being used by certain entities without there being any real-time check, control, and due diligence on their credentials."

The High Level Committee on Capital Market had suggested making it mandatory for FIIs to issue PNs only to entities that are regulated by a financial regulator in a country.

However, last year the Lahiri Committee on `Encouraging FII inflows and checking the vulnerability of capital markets to speculative flows' had favoured continuation of the PN system but suggested that the SEBI should have full powers to obtain information on the holder of the PN or the final beneficiaries of the securities bought or sold at any time in case of investigations.

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PN most preferred route for FII investments