The Hindu Business Line : Will the curbs work?

The SEBI Board quite expectedly endorsed the market regulator’s draft recommendations on offshore derivative instruments such as ‘participatory notes’. The tight time-line since the announcement of the draft proposals, submission of comments, evaluation by SEBI and approval by the Board would seem to suggest that SEBI had more or less decided to ratify the draft measures. It was perhaps only waiting to discern from the post-announcement market movement that it had gauged the market mood right. The prices of pivotal stocks, no doubt, did decline in the initial days following the announcement of draft proposals. But that may as easily be attributed to a healthy correction as to an adverse reaction to the curbs on FII investment. In any case, the rally in equity values in the last two days suggests that it is business as usual for the market.

For SEBI, the primary concern is perhaps that the offshore derivative instruments mask the identity of their ultimate beneficiaries by creating one more layer between the investing institution and the ultimate beneficiary of such investments. But there has also been concern that such unbridled flows, seeking perhaps nothing more than a positive movement in the rupee-dollar exchange rate, could create a bubble situation in equity values. Such large foreign portfolio investment flows have also monetary policy implications, on prices, interest rates, exports, output, and so on. . These are too important to be ignored. The question is: Does the outright ban on investments in derivative instruments of Indian stocks by FIIs and their affiliate ‘sub-accounts’ through the medium of participatory notes address these issues adequately? Or, for that matter, does a cap on such investments by foreign institutional investors using PNs meet these concerns?

SEBI has taken on a challenging task. Its latest measures seek to match a specific source of FII funds with specific investments made. But FIIs do mobilise funds through a multiplicity of sources, each with unique characteristics. They can also contend that a particular instrument is not linked to an underlying Indian security. Disputes on specific transactions could easily get locked in litigation. There is every incentive for a foreign investor to resort to clever financial engineering as the fundamentals of the Indian economy make investments very attractive. The mere prospect of the continued strengthening of the rupee against the dollar would be sufficient to bring in funds into the Indian market. The days ahead are bound to show how far the latest measures help curb speculative overseas money.

Related Stories:
Only ‘regulated’ entities can invest thru PN route
All 20 sub-accounts opt to enter through ‘front door’
What are ‘Participatory notes’?

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