The Hindu Business Line : P-Note regulation only a cosmetic change: Analysts

Mumbai, Oct. 6 SEBI’s restrictions on issue of P-Notes by FIIs and its decision now to remove them will have only a cosmetic impact on the inflow and outflow of foreign funds, said market participants. In October 2007, FIIs were banned from issue of P-Notes with underlying derivatives, and a 40 per cent limit on P-Notes assets was imposed. FIIs hardly reached anywhere close to these limits, said sources.

Those FIIs who exceeded the 40 per cent limit were allowed to maintain their current P-Notes levels anyway, so that the five to seven such FIIs who accounted for the bulk of the P-Notes market were unaffected.

Liquidity criterion

Monday’s lifting of the P-Notes restrictions by SEBI would not make much of a difference either, said marketmen.

In fact, the P-Notes restrictions of October 2007 hardly deterred FIIs who went on to invest in the Indian markets, which touched an all-time high in January 2008.

“FII inflows and outflows have been determined by their liquidity situation overseas more than anything else,” said an official with a broking firm. “It is only the perception of the Indian markets that has been affected by the P-Notes announcements.”

No changes have been made to the norms of registration and regulation required of foreign funds, nor to the KYC norms to be maintained by them with respect to their sub accounts.

Offshore derivative instruments can only be issued to persons regulated by an appropriate foreign regulator authority. Those not regulated must close out their positions by March 2009.

‘Detrimental effect’

SEBI’s basic intention was to bring in transparency and to get foreign funds to invest upfront in the Indian market when it amended the FII regulations, notifying them in May. To this end, the regulator had thrown the FII arena open to a whole lot of entities, including new funds, whereas earlier only funds with a track record could apply.

NRIs, though not eligible to apply as sub accounts, were now eligible to apply as FIIs. OCBS too, by implication, were eligible to apply as FIIs under the amendments.

Monday’s relaxing of the policy on P-Notes is a step back in the general direction of transparency to which the amendments pointed, said a legal expert.

As the changes announced by SEBI are silent on sub-accounts, it may be assumed that the ban on issue of P-Notes by them remains. Since this is so, it may be assumed that foreign funds would now prefer to come in as FIIs because unlimited issue of P-Notes by them is now possible. But even when the ban on sub accounts was already there, it has hardly been the pattern that investors have preferred to come in as FIIs, to even make use of the 40 per cent P-Notes limit, said marketmen.

Sub Accounts

SEBI data show that the increase in number of sub accounts has far exceeded the increase in number of FIIs since the October restrictions.

All announcements made on Monday would eventually have to be notified.