P-Notes running out of favour

Foreign institutional investors (FIIs) have reduced their use of participatory notes (P-Notes) from the hey-days of 2007, notwithstanding the recovery in the domestic equity markets.

Experts attribute this to the effect of the economic meltdown on hedge funds as well as to the facilitation of faster registration by the Indian stock markets regulator.

P-Notes are instruments that allow FIIs not registered in India to invest indirectly in Indian markets. These are issued by the registered FIIs.

The total value of P-Notes with underlying Indian securities when the markets were at their peak in January 2008 was Rs3.3lakhcrore, accounting for 38.6 per cent of the Rs8.6lakhcrore of assets of FIIs.

P-Notes hit a peak in June 2007, when they accounted for 55.7 per cent of the total FII holdings.

According to Sebi data, the ratio has come down to 15.5 per cent by August 2009. The P-Note route now accounts for Rs1.1lakhcrore of the Rs7.1lakhcrore assets of FIIs.

“The P-Note route tends to be used by hedge funds and other such entities. These are not very active right now,” said Vikas Khemani, co-head of institutional equities at Edelweiss Capital.

“The financial crisis in the US and Europe has hit hedge funds. When these funds cut exposure to India and emerging markets, use of P-Notes would get hit too,” said Ajay Pandey, AVP, institutional sales, at Intime Spectrum Securites.

At the same time, Sebi has made it easier for FIIs to come in directly into Indian markets. “FII registration is easier now. Also, it results in lower costs for the investor… so many people prefer to go the direct route,” said Vikas Khemani.

“Sebi has encouraged direct registration, and the process is considerably faster now. Approvals used to take two quarters and now they are got within a quarter,” said Amit Khurana, co-head — institutional equities, research, Mangal Keshav.

Since P-Notes form a potentially anonymous means of investing in Indian markets and, looking at the surge in its use, Sebi had put caps on its use in October 2007. The regulator was also concerned of a liquidity-fuelled bubble building up in the stock markets.

A year later, faced with massive deleveraging and withdrawal of money from Indian markets, Sebi reversed its stand on P-Notes and allowed for their use as before.
However, though the FII inflows are likely to be high, the use of P-Notes is unlikely to pick up in a big way, suggest experts.

FIIs were net sellers by Rs55,000 crore in 2008. They have been net buyers by over Rs60,000crore in 2009.