The Hindu Business Line : PNs: Route set for smooth transition

The clarifications issued by SEBI after its board meeting on Thursday has removed most of the doubts and concerns that arose after the issue of the draft discussion paper on offshore derivative instruments last week. The SEBI board has approved the proposal to stop the FIIs and their sub-accounts from issuing or renewing participatory notes (PNs) with derivatives as underlying. There would be no immediate impact of this move on the markets since the regulator has allowed 18 months for the unwinding of the existing positions. The PN holders can unwind their positions at the appropriate time over the next year and a half.

The Chairman, Mr Damodaran, has also clarified that FIIs who have issued PNs in excess of 40 per cent of the assets under custody need not bring down this limit to 40 per cent. They can issue fresh PNs against cancellation or redemption of the existing PNs.

That is, they can maintain the outstanding levels that were present on September 30. What this boils down to is there will be no selling pressure on the markets caused by FIIs rushing to bring down the level of PNs outstanding.

For biz as usual

Another way in which the regulator has ensured smooth enforcement of the proposal without causing further turbulence in the markets is by allowing both corporate and proprietary sub-accounts which have submitted letter of intent to register as FIIs to continue to do business as usual until SEBI approves their registration.

The date for calculation of the assets under custody (AUC) has been fixed with retrospective effect at September 30, 2007. Since the FIIs file monthly reports with the regulator, this is the latest data on PNs issued by FIIs, available with SEBI.

The front-door has been opened wider by allowing pension funds, charitable institutions, universities and endowment funds to register as FIIs even if they are un-regulated entities. Since many such institutions are currently using the hedge fund route to enter the Indian markets, allowing them direct access increases the dispensability of the PNs.

Applying the 1-year track record criteria to fund managers instead of the fund, and changing the definition of broad-based funds to increase limit of the stake of a single investor to 49 per cent from 10 per cent, are other relaxations that would make it possible for a larger number of funds to register directly with SEBI as FIIs.

Regulated vs Registered

The screw has, however, been tightened by making it mandatory for the PN issuing authority to ensure that the participatory notes are issued only to ‘regulated’ entities and not just ‘registered’ entities. This will make it difficult for unregulated hedge funds (though many hedge funds are regulated) to invest in the Indian equities through this route. Hedge funds can of course register directly with SEBI.