Foreign institutional investors (FIIs) are upset at a decision of the Securities Exchange Board of India (Sebi) to put a sunset clause on investment limits in bonds.
To invest in the bond markets, FIIs are required to buy investment limits auctioned from time to time. So far, if FIIs bought a limit to invest in bonds (government, infrastructure or corporate bonds), that limit was for perpetuity. So, FIIs were paying a premium to buy the limits.
Yesterday, a Sebi notification said: “It has been decided that, henceforth, re-investment period shall not be allowed for all new allocations of debt limit to FIIs/sub-accounts.” Even the existing limits shall expire if the total sale from the debt portfolio is twice the size of its portfolio, as on the date of the circular.
Effectively, FIIs would be able to churn their portfolio only twice, after which the limit would expire. Alternatively, the limit would expire after two years. Fresh limits will be auctioned subsequently through bidding.
In December alone, FIIs bought limits worth Rs 50,000 crore, for which they paid an estimated Rs 500 crore as premium. With the new notification, FIIs claim they would not be able to recover their costs, as these limits would expire at the end of two years.
In 2011 calendar year, FIIs pumped in Rs 40,770 crore into the debt market. Despite the weak global sentiment, FIIs have not withdrawn money from the Indian debt market.
But with this notification, most participants claim their confidence has been shaken and withdrawals would be the obvious thing to do. Most FIIs say changing the rules of the game with retrospective effect has hit sentiments.
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Market participants say a few FIIs had cornered a large part of the limits, making it difficult for other players to enter the bond market. To resolve this issue, the regulator has decided to put a sunset clause on all existing and new limits of two years. Participants say they should have been given time to readjust their portfolio, even if the notification was in the offing.
While it is seen as a positive from a long-term perspective, foreign investors are stumped by the timing of this decision. A market participant says: “While this is the right thing to do, it has been done in a wrong way. Just a month ago, limits were auctioned and now this new notification has come. The fair thing to do would have been to return the premium to participants and then the limits could have been re-auctioned.”
At the time of the auction a month ago, there was no mention of the expiry of these limits. The head of global markets at a foreign investment bank says the regulation has changed the rules of the game after FIIs paid for the limits, presuming those were for perpetuity.
In the current environment, the participants will find it very difficult to recover the fees they had paid.