Regulators concerned as no specific rules govern these products.
Some leading brokerages are selling complex derivatives products to their portfolio management service (PMS) clients in the garb of structured notes, taking advantage of the ambiguity in rules governing such products, according to officials familiar with the matter.
Derivatives are supposed to be sold subject to various riders, unlike structured notes. The products in question, say officials, are far more akin to the former than the latter.
Typically, these brokerages are buying synthetic derivatives products on behalf of their wealthy customers from non-banking financial companies (NBFCs) owned by foreign banks.
At present, there are no specific rules in India governing equity-linked structured products sold by brokerages to their PMS clients. This, officials say, is the main reason behind mis-selling of these complex derivatives products.
“Brokers don’t even disclose the agreement signed between them and NBFCs to clients, taking advantage of regulatory loopholes,” said an official on condition of anonymity.
The Securities and Exchange Board of India (Sebi) regulations for portfolio managers don’t specifically ask brokers to disclose the agreement signed with NBFCs to their clients where this information is relevant for the latter. An e-mail query sent to Sebi officials on the subject remained unanswered.
These synthetic derivatives, marketed as capital protection structured notes, have an equity index like Sensex or Nifty as an underlying. They can also have a single stock, like Reliance Industries, as an underlying. These products are even customised for a single PMS client.
The returns for investors from these instruments, in which the minimum investment is kept at $1 million (Rs 4.5 crore) in some cases, depend on various conditions. For example, in one such Nifty-linked synthetic derivatives product, whose product note was reviewed by Business Standard, the tenure was 12 months with payout for investors after 15 months. The barrier event was fixed at 25 per cent.
This means if the Nifty is at 5,000 at the time of the launch of the product and moves to 6,250 any time during the 12 months, the product expires and the investor gets his principal and a pre-decided coupon of 10.75 per cent after 15 months. In case the Nifty remains between 5,000 and 6,250 at the end of 12 months, the investor gets principal plus index return and 10 per cent extra on the index return. If the Nifty falls below 5,000, the investor gets back only his capital after 15 months.
These complex derivatives products are marketed to high net worth individuals who want to protect themselves against a fall in the market and also want to benefit from the potential upside.
