Sticking to its original proposal to slap curbs on participatory notes (PNs or P-Notes), the Securities and Exchange Board of India (Sebi) today approved new rules for investment by foreign investors that will force them to come through “the front door” and reduce the flow of unregulated funds into the stock markets. The Sebi board asked foreign investors to wind up P-Notes in the derivative segment within 18 months and put restrictions on the use of PNs — issued to foreign investors who are not registered with the Sebi — in the cash market. “The proposal that foreign institutional investors and their sub-accounts should not issue P-notes with underlying as derivatives has been approved by the board. The related decision that the current position would be wound up over 18 months has also been approved by the board,” Sebi chairman M Damodaran said after a board meeting here. “The board also decided that further issues of P-notes by the sub-accounts would be discontinued with immediate effect, and they would be required to wind up their current position over 18 months. During this period, SEBI would review the position from time to time as has been indicated in our draft proposal,” he said. On the other hand, the regulator has also decided that FIIs will not be allowed to issue P-Notes more than 40 per cent of their assets under custody. The reference date for calculating such assets will be September 30, SEBI said. The provision will come into immediate effect. Retaining the original proposal, Sebi said those FIIs which have issued P-Notes of more than 40 per cent of their assets, could issue such instruments only if they cancel, redeem, or close their existing PNs. FIIs which have issued P-Notes less than 40 per cent of their assets under custody can issue additional instruments at the rate of five per cent of their assets every year. “Only a handful of people are above the 40 per cent limit. We arrived at the 40 per cent by looking at numbers that were available with the custodians and that it wouldn’t be hugely disruptive,” Damodaran said. Sebi came out with a discussion paper on curbing PNs on October 16. The plans led to a stock market crash the next day with the Sensex plummeting 1,700 points within minutes of opening. However, the market recovered after Finance Minister P Chidambaram and Damodaran assured that the steps were not aimed at curbing P-notes. Almost half of the foreign money that flowed into the markets recently was through P-Notes. A record $17.5 billion came to the Indian market in 2007, propelling the Sensex to new peaks daily. Though the Sensex has been volatile and lost over 1500 points in the next three sessions after the Sebi proposal last week, the market has recouped most of the losses this week. Today, the Sensex closed with a gain of 258 points at 18,770.89.At its meeting today, the regulator also decided to register entities like pension funds as a FII category. “The philosophy underlying this is to see that quality investors come in, and therefore pension funds, foundations, endowments, university funds, charitable funds or societies, which do not strictly fit in to the framework today, are being enabled by keeping them as a category that we will recognise,” he said. Sebi also clarified the track record of foreign investors. “There have been issues faced regarding the provision of track record of the applicant, and we have been told that a new entity cannot have a one-year track record. We recognise that, and to facilitate that but without doing away with the track record provision, we now say that a fund manager of an entity would be required to have a. track record of one year and not the newly constituted entity with a track record of one year,” Damodaran said. The Sebi chief also said there’s no evidence of terror money in the market. “Money that comes to our market comes through banking channels. Every intermediary is expected to follow the KYC (know your customer) norms, whether it is the depositary participant or whoever else, so there are several level of checks to see who is recipient, the broker or else,” he said. As part of simplifying the registration process, Sebi also decided that FIIs can be registered on a permanent basis instead of the earlier practice of renewing registration every three years. Earlier this week, Sebi had asked sub-accounts of FIIs that issue P-Notes to register as FIIs for investing in the Indian capital market. This was to make sure that all foreign funds come to the country through the front door. Following SEBI’s directions, as many as 20 such investors had offered to register as FIIs. Market experts welcomed the Sebi proposals. “The concerns of regulators regarding PNs have been known for a long time and I fully support a complete ban on P-Notes alongside more liberal FII registration norms. I disagree that this move will have a dampening effect on capital flows into the country . In fact this will only help in increasing capital flows due to better transparency and financial stability,” said Manoj Vaish, President & CEO-India, Dun & Bradstreet.With immediate effect• P-notes in derivative segment to wind up in 18 months • Restrictions on p-notes in cash market on basis of assets under custody• Reference date for asset calculation is Sept 30• New proposals with immediate effect• Sebi to consider 1-yr track record of fund manager, not firm • FIIs to be registered on permanent basis, 3-yr renewal scrapped• Foreign pension funds, foundations, endowments, university funds, charitable funds to be allowed
