SEBI has virtually shut the doors on Participatory Note investments in India. The move could put severe pressure on the stock market as equity derivative positions of over ₹40,000 crore are held via P-Notes, most of which would be unwound, leading to a domino effect on cash equities.

SEBI had on Friday banned foreign portfolio investors (FPIs) from issuing P-Notes where the underlying assets are equity derivatives, and ordered unwinding of existing contracts. The new norms say P-Notes are not allowed if not for hedging. “SEBI has virtually shut down PNs,” said Suresh Swamy, Partner, PwC. “P-Note unwinding may accelerate in the days to come.” Swamy believes trading could now shift offshore.

SEBI has defined hedging as “taking a one-to-one position in only those derivatives, which have the same underlying as equity shares.”

Simply put, an FPI can hold 10 derivative lots of Infosys only if it is holding Infosys in cash. It is too naive a definition for “hedging”, the term otherwise subjectively used in trading parlance. For instance, holding bank shares and going short on the Bank Nifty or Nifty index is also referred to as “hedging”.

SEBI’s definition sounds narrow and restrictive and may affect current FPI trades, which may not fit regulatory criteria.

“It would be a race to unwind,” said the fund manager.

FPIs hold P-Notes of over ₹1.9 lakh crore in cash and ₹40,000 crore in derivatives. SEBI has ordered unwinding on expiry of derivative contracts or year 2020, whichever is earlier. That’s effectively three months, as most futures trades are not longer than that.

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