P-Notes: foreign investors close holdings lock, stock and barrel

The ghost of participatory notes (P-Notes), the perceived ‘hot money instruments,’ may no longer haunt India’s stock markets. This month derivative traders bid adieu to P-Notes, a key cause for some of the historic stock crash events in India.

From around ₹47,000 crore in June, foreign portfolio investors (FPIs) cut down their P-Note positions in the equity derivative segment to nil, stock brokers said. Latest data shows that as on August 31, FPI positions in equity derivatives via P-Notes stood at just around ₹8,000 crore, which stock brokers say is now non-existent.

A near 10 per cent or 1,744 points crash in the Sensex on October 17, 2007, was the first time when India became aware of the influence that P-Notes wielded on its stock markets. Then, just a day before on October 16, SEBI had expressed its concern with regard to rising P-Note holdings and the markets plunged with the opening bell the next day.

High derivative position via P-Notes came to be blamed for the sudden crash as talks of SEBI’s concerns sparked massive unwinding and even short-selling via the use of this instrument.

“P-Notes were often much feared as overseas traders who subscribed to these instruments, even lent it further to third parties for short-selling,” said a Mumbai-based broker.

In 2007, nearly half of India’s ₹10-lakh crore worth of debt and equity positions by FPIs were held via P-Notes. The instrument had a lion’s share of the derivative positions and often caused massive volatility on derivative expiry.

The lending and borrowing of P-Notes was stopped by SEBI in the second half of 2008 at the peak of the financial crisis when global regulators were thinking of banning short-selling. P-Notes then were used like a swivel door by unregistered entities to enter and exit the Indian markets.

The total value of P-Note holding in India as of August 31 stood at ₹1.25 lakh crore, of which ₹88,000 crore was in the equity cash segment, data showed. This P-Note holding in equity and debt is the lowest since February 2010.

After years of gradual clampdown, SEBI in August announced the death knell for P-Notes. The regulator said P-Notes could no longer be used except for the purpose of hedging. SEBI made the definition of hedging for this purpose so narrow that it stole the charm of the instrument in the derivative segment. SEBI also imposed a fee of $1,000 for P-Note users. Only 4.1 per cent of FPIs’ entire investment in debt and equity markets is not accounted by P-Notes.

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