ENS
ACOUPLE of weeks ago when the BSE SENSEX posted an all-time high and went past 19,000 points, it was followed by a frenzied curiosity when will SENSEX go past 20,000 points – will it be before Diwali or after.
But, in came the P-Note fiasco resulting in mayhem in the markets.
What is a Participatory Note and why the concerns on investments through PNotes?
P-Notes are offshore derivative instruments (ODIs) issued to foreign investors, which may be hedge funds (that are not welcome by SEBI), foreign pension/mutual funds, or high net worth individuals abroad, by SEBIregistered foreign institutional investors (FIIs) in India.
The note issued against an underlying security, entitles the holder to a share in the income, either dividend or capital gain, from the underlying security. In short it is an instrument which facilitates foreign investments in Indian stock markets without any registration with regulators.
The underlying securities/shares of listed companies in India are held in the custody of FIIs on behalf of the PNote holders. FII brokers buy and sell securities on behalf of their clients on their proprietary account and issue such notes in favour of their foreign clients.
Why do foreign investors use the PNote route?
Because:
(1) It is easy to enter (invest) and exit the market; (2) Investors who do not qualify to register as FIIs for some technical reasons and those who prefer a less cumbersome (many FIIs complain that registration process with SEBI is time consuming) and cost effective method use P-Note route.
Why concerns on P-Notes?
(1) Lack of transparency and anonymity of investors and difficulty in tracing the source/identity and quality of the funds coming through P-Notes route (though as per the regulations, FIIs are under obligation to submit monthly reports on the identity of the holders of P-Notes, most FIIs express their inability to give the identity of the ultimate beneficiaries, as P-Notes are transferable instruments), is a concern to regulators.
(2) There are fears that P-Notes are ideal money-laundering vehicles.
(3) In a way FIIs are creating their own parallel offshore market for Indian securities in derivative form – which will take away volumes and revenues from Indian stock markets.
(4) There are apprehensions (and some evidence) that the P-Note route was being used for ‘re-entry’ of resident Indians’ money. These funds were sent out of the country by questionable means and were returning to the market in the form of P-Note.
How are the markets expected to behave going forward?
FIIs are largely responsible for structural bull market rally and unidirectional rise of SENSEX from 17,000 to 19,000 plus, without any significant correction/ consolidation, in quick time.
Bull markets, regardless of regulations tend to produce excesses and make people lose their sense as they become greedy. Since, SEBI/Government do not want to get caught napping, they are understandably trying to moderate the large capital flows, through P-Note route, into Indian markets.
The timing of SEBI’s move could not have been better. The step would invariably result in continuing volatility in the markets in the short-term and more particularly in the coming week since both SEBI’s meeting on P-Note issue and October series derivative expiry, are scheduled to happen this week.
Depending on the outcome of SEBI’s meeting on October 25, FIIs may reposition their portfolios and this may create a flutter in the stock market over the next few weeks.
But in the long-term it would help consolidate the markets, as India’s growth story is still intact. With the Indian economy growing at a steady 8-9 percent annual growth, FIIs may not prefer to exit Indian equities in a hurry.
So in the interim, if you are a short-term investor sitting on profits, you can look to book some profits and use the correction to reenter, when consolidation happens.
If you are a long-term investor with a time horizon of say more than three years, you can use the fall to accumulate a portfolio of blue chips/ fundamentally strong companies, which were beyond the reach of many retail investors in the recent past.
