The group said that a negative list of tax havens, whereby entities registered in these jurisdictions are prevented from attaining FII status, should be prepared.

R.Y. Narayanan

Coimbatore, Dec. 15

AN official expert group headed by Dr Ashok K. Lahiri, Chief Economic Adviser, Department of Economic Affairs, Ministry of Finance, has cautioned against the `potential abuse' of the FII route by Foreign Direct Investors (FDIs) and has therefore argued for putting in place, appropriate regulation of issue of Participatory Notes (PNs) and sub accounts.

While stating that the current dispensation for PNs might continue, the report said that "SEBI should have full powers to obtain information regarding the final holder/beneficiaries or of any holder at any point of time in case of any investigation or surveillance action. FIIs should be obliged to provide the information to SEBI."

Pointing out that market integrity concerns could get heightened when funds of unknown source or funds arising out of laundered money are involved, the group said that a negative list of tax havens, whereby entities registered in these jurisdictions are prevented from attaining FII status, should be prepared.

It has also suggested that temporary capital controls through either Quantitative Restrictions (QRs) or price-based measures could be considered during periods of extreme volatility that may be triggered by external events.

Dissent note: However in his dissent note on the report, Mr Vinay Baijal, Chief General Manager, RBI, a member of the expert group, reiterated the RBI's stand that `the issue of Participatory Notes should not be permitted'.

He said the main concerns regarding PNs were that the nature of the beneficial ownership or the identity of the investor would not be known and trading of these PNs `will lead to multi-layering'. Restriction on suspicious flows enhances the reputation of markets and leads to healthy flows, he felt. He suggested that a closer look be had at any hedge fund registered with SEBI for deregistration. He also suggested the formation of a special group to study measures to contain large volatility in FII inflows as a priority.

He said data available with the RBI showed that out of 5,499 companies that have FII investments, only 100 companies have passed resolutions to permit increase in FII holding beyond the limit of 24 per cent. The requirement that special resolutions should be passed by shareholders in an EGM and by the company board to enhance the FII limit beyond 24 per cent wherever applicable should continue.

Deepening markets: The expert group also pointed out that FII flows would be encouraged by "greater volume of issuance of securities" in the domestic market and "this would be assisted by the PSU disinvestments."

It cited how the IPOs of GAIl, ONGC and NTPC helped deepen the markets. Companies that are executing large projects in the infrastructure and telecom sectors should also be encouraged to access the domestic capital markets, the report said.

Hedge fund: It suggested that `a concept of a Domestic Hedge Fund' might be created, through appropriate SEBI regulations, to play a comparable role in the market based on purely rupee investments. There is merit in closely watching the regulatory developments with regard to hedge funds in the US and elsewhere and formulating policy on the basis of the experiences of these countries later. It also felt that the entry of the domestic pensions funds in the equity market would augment the `diversity of views' on the market and end the anomalous situation wherein foreign pension funds are extensive users of the Indian equity market while the domestic pension funds are not investing.

Related Stories:
FIIs continue to make a beeline for Indian bourses
Participatory notes account for over 40 pc of FII inflows

(This article was published in the Business Line print edition dated December 16, 2005)
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