I was at the gym Tuesday night when the ticker flashed on CNBC-18 – “SEBI issues a report on P-Notes.” My first reaction was “fu!#@$ the markets are going to crash.”
The report by the Securities and Exchange Board of India (SEBI) outlined measure to control the foreign flow of funds into India via P-Notes. Of course, it wasn’t so clear in the report and that led to speculation that the gov’t was shutting the door on foreign funds.
When the market opened on Wednesday at 9:55am, within 45 seconds the Sensex had dropped over 1700 points and triggered a one hour trading stop. Which was expected because many people inferred that foreign money would have to exit India. However, around 10:35am the finance minister P. Chidambaram came on TV and said the reason for limiting P-Notes was to steer foreign funds down the path of FII registration with SEBI.
A little history on participatory note (P-Notes), they are basically swaps issued by a Merrill or Goldman. If you are a fund and want to trade Indian equities you have two options:
1. Register as a Foreign Instituional Investor (FII) with SEBI. Dealing with any Indian governement entity is a pain, but SEBI has been especially painful. I know of several funds that tried to register but got rejected because their marketing material used the term “hedge fund.” SEBI wants full transparency and hence doesn’t like hedge funds…or so they say.
2. Skip all registrations and goto Merrill or Goldman and open a prime brokerage account. When you hit the buy button on 20,ooo shares of Reliance, Goldman will buy the shares for you and hold it in their name. Then Goldman issues a bilateral financial contract (aka P-Notes) to synthetically replicate the economic returns of the underlying shares. The problem is that this creates a hugh reporting void for SEBI, since they don’t know who actually owns the shares. So SEBI in effect is driving hedge funds to act like hedge funds and be opaque about their holdings.
In summary, hopefully this shift away from P-Notes to FII registrations will give the market more clarity and SEBI more transparency it so badly wants.