The stock market regulator seems to have decided to rein in the bull run. In a move aimed at curbing the inflow of foreign funds into the stock market that has risen sharply in recent weeks, the Securities and Exchange Board of India (SEBI) has proposed to ban investments through participatory notes issued by foreign institutional investors (FIIs).
Participatory notes are bilateral contracts between FIIs and investors for taking exposure in specific stocks without registering themselves with SEBI. This helps hiding the identity of the real investors.
Currently, 51 per cent of the FII investment in the Indian stock market is through participatory notes.
The SEBI proposal follows Finance Minister P Chidambaram's comment at the HT Leadership Summit last week. He had said that the Sensex was being driven by "copious inflow of funds from a number of sources abroad".
Echoing that, the market regulator said, "The copious inflow (of funds) into the country from foreign investors has been engaging the attention of the government and the regulators such as the RBI and SEBI." The regulators have posted a document 'Paper for discussion on Offshore Derivatives Instruments' on its website on Tuesday. The SEBI has invited comments from market experts by October 20, before taking a final decision to this effect.
The FIIs inflow is in excess of $8 billion and large part of this comes through participatory notes. As per SEBI figures, the notional value of participatory notes has increased to Rs 3,53,484 crore in August 2007 from Rs 31,875 crore in March 2004.
Therefore, the SEBI has proposed: "FIIs and their sub-accounts shall not issue or renew offshore derivative instruments (ODIs) with immediate effect. They are required to wind up the current position over 18 months, during which period SEBI will review the position from time to time."
When FIIs enter into contract with another overseas financial intermediaries, they open a sub-account, which issue participatory notes to other investors. Therefore FIIs can issue participatory notes directly or through some intermediaries (sub accounts).
The market watchdog has also proposed that further issuance of ODIs by the sub-accounts of FIIs would be discontinued with immediate effect and they would need to wind up the current position over 18 months.