P-notes on equity derivatives touch a five-year high

Foreign investors not registered with the Securities and Exchange Board of India are again displaying a keen interest in playing the Indian derivatives.

This is revealed by participatory notes (PNs) based on equity derivatives hitting a five-year high recently.

PNs are contracts issued by FIIs and sub-accounts registered with the SEBI to investors in other countries. Reasons for unregistered foreign investors using this route could range from the speed of transacting to the need for anonymity.

Regulators look askance at these instruments because they are a conduit for short-term money from sources such as hedge funds that can cause volatility in stock prices.

According to data published by the SEBI, value of PNs issued with derivatives as underlying towards the end of August was at a five-year high of Rs 73,260 crore.

The last time this number exceeded Rs 70,000 crore was in October 2007. But it also needs to be noted that the Indian equity derivative segment has more than doubled in size since 2007.

Less of a worry

The total PN issuances are down sharply since the heydays of 2007.

The total PNs outstanding on August 31 was Rs 141,710 crore, which is only a third of the outstanding PNs in October 2007, when the market regulator had clamped down on the issue of these instruments.

With regard to the proportion of PNs in FII assets also, the position now is far more comfortable. While these instruments accounted for over 50 per cent of FII assets in mid-2007, the share is now down to 12 per cent.

PN issuance was down immediately after this year’s Union Budget when there was confusion about the applicability of General Anti-Avoidance Rules on these instruments.

But with the implementation of GAAR postponed initially for one and then three years, FIIs appear to be going full speed ahead with these issuances.

The value of PNs on equity derivatives has increased 62 per cent in the first eight months of this year.

Domestic FIIs

Registered foreign institutional investors (FIIs) are also displaying greater interest in the equity derivative segment this year.

The gross turnover of FIIs in this segment in the first eight months of this year was 47 per cent higher than the same period last year.

Higher volatility in Indian stock prices with prices swinging sharply appears to have attracted both FIIs registered with SEBI as well as foreign investors not registered with the Indian regulator to take bets on Indian stock price moves through equity futures and options.

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