Sebi stands ground on P-notes

Regulator approves all draft proposals, simplifies registration procedures.

The Securities and Exchange Board of India (Sebi) on Thursday stuck to its ground on the issue of restricting participatory notes (P-notes) and virtually retained all the clauses that were put up for public comment last week.

Speaking to reporters after the Sebi board meeting, Chairman M Damodaran said foreign funds will have to register in India before investing in P-notes or sell their holdings within 18 months. The new rules will be enforced with immediate effect.

The regulator also barred the issuance of P-notes tied to derivatives.

P-notes are securities linked to equities used by investors who cannot trade directly in the Indian market. Last week, Sebi had suggested restricting their use to curb burgeoning capital flows into the country.

In the spot market, foreign institutional investors (FIIs) will not be allowed to issue P-notes that were more than 40 per cent of their assets under custody. The "handful" of funds over the threshold will have to freeze their holdings, Damodaran said.

FIIs that have issued P-notes below the limit may increase issuances at an incremental rate of 5 per cent of their assets under custody, he said.

The reference date for calculating such assets will be September 30, which is the latest date for which data is available, Sebi said.

Institutional investors that have applied to register sub-accounts can continue trading while their application is being processed, Damodaran clarified.

Foreign investors currently registered in India will not be allowed to issue new derivatives from sub-accounts based in tax havens such as Mauritius.

As of October 23, there are 1,119 registered foreign investors and 3,447 registered sub-accounts.

Experts said many hedge funds that were not regulated in their home country will find it difficult to invest in the Indian market and the atmosphere will be more conducive for dedicated India funds.

Experts were not sure of the way the markets will react tomorrow to the new P-note regime. While some said the markets had already factored in the proposals, others said the stock exchanges may open weak tomorrow.

The Sensex has been volatile since the proposals were put up for public disclosure, prompting a one-hour closure on October 17. It closed 258 points up on Thursday at 18,770.89 points on expectations that Sebi may dilute the stringency of the P-note regime.

In its press note, Sebi also changed the eligibility criteria for certain categories of investors that do not qualify as FIIs but want to register with the regulator directly.

These entities include pension funds, foundations, endowments, university funds and charitable trusts or societies, which do not come under any regulatory authority in their respective countries.

On other categories of investors, Damodaran said the entity will have to be regulated by the home country sectoral regulator. For instance, if a bank wants to register as an FII it has to be regulated by the banking regulator.

Sebi has also drawn up what it calls "broad-based criteria" for P-note holders that want to register as FII. Such entities should have at least 20 investors and no single investor can hold more than 49 per cent (instead of 10 per cent at present). With this relaxation, many new investors will be eligible for registration.

Sebi also said that it will consider the track record of individual fund managers instead of the fund for registration. This is because funds with a track record of less than one year were earlier not eligible for registration as FIIs.

In another significant step towards removing procedural problems, the regulator said FII and sub-account registrations will be allowed in perpetuity.

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THE NEW REGIME

FIIs and sub-accounts to wind up P-notes for investing in derivatives within 18 months

FIIs will not be allowed to issue P-notes in the spot market for more than 40% of their assets under custody

Those FIIs that have issued P-notes less than 40% of their assets under custody, can issue additional instruments at the annual rate of 5% of their assets

The reference date for calculating such assets will be September 30

The registration procedure is being simplified; FII registration to be in perpetuity

Separate category of unregulated investors, such as pension funds and charitable trusts, to be allowed

Fresh look at FII regulations