The timing says it

The fact that the Securities and Exchange Board of India chose the anniversary of Black Monday to announce a ban on participatory notes issued by UBS Securities has resulted in the order being greeted with widespread scepticism by the market.

From the beginning, it is alleged, the inquiry's aim was not so much to unearth the facts as to find scapegoats for what amounted to a loss of face for the new government. So, while a dozen market players were issued show-cause notices months ago, action has been taken against just one""and that too is not for what happened on that eventful day.

Although May 17 was an exceptional day for the Indian stock market, emerging markets across the world were hammered in May last year, ahead of the US Federal Reserve increasing its Fed Funds Rate on June 30. To be sure, the Indian market was one of the hardest-hit in last May's sell-off, but then it had to grapple with an unanticipated change of government, and provocative and irresponsible statements by spokesmen for the Left.

Whether all this justified a sell-off in the markets is beside the point; the fact is that these triggers acted as an opportunity for market participants to make money, sometimes by selling short in the futures market.

It's noteworthy, therefore, that Sebi has found no evidence of market manipulation by UBS, and its order banning UBS from issuing participatory notes for a year is the result of the foreign investor allegedly not following the "Know Your Customer" norms, for not exercising due diligence, and for not furnishing timely information to the market regulator.

Sebi has further said in its order that there's regulatory concern because participatory notes are being issued without due diligence on the part of FIIs. Sebi has also said that UBS was delaying furnishing the information, lest the same should be inconvenient; however, Sebi has not shown whether the information finally furnished by UBS was, in fact, "inconvenient".

The issue of participatory notes is, therefore, at the heart of the matter, and the Sebi order has little to do with the events of May 17 last year. Instead it is part and parcel of the market regulator's attempt to ensure that it is able to trace the source of funds into the market.

That is what lies behind the regulator's numerous queries to UBS to disclose the investors in its participatory notes. This attempt to find the ultimate source of funds is doomed to failure. Even if the beneficiary of a participatory note is traced, how will one ensure that that beneficiary is not acting on behalf of another group? And what if a bank has to deal with customer secrecy laws in its home country?

Another problem is that of jurisdiction""UBS contended that in some of the cases, it was already following the "Know-your-customer" requirements of the UK's Financial Services Authority. Whether Sebi has made the right decision in the UBS case or whether it will be overturned on appeal, as has happened so often in the past, remains to be seen. But on the issue of participatory notes, it needs to temper its zeal for regulation with a degree of common sense.