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Relaxed PN Norms May Not Help Inflows

The SEBI has decided to lift some of the restrictions imposed on participatory notes (PNs). The idea is to further facilitate foreign capital flows into the stock market. FIIs have been net sellers to the tune of $9.2 billion so far this year. The question is whether easing the PN regime will, by itself, bring FII flows back. Quite unlikely, considering that the massive deleveraging on Wall Street will take some time to play out fully.

Besides, the tightening of the PN regime was done with the primary objective of making large hedge fund investments coming through the PN route more transparent by asking them to directly register with SEBI. At one point, over 50% of the fresh FII investments were coming through PN investors whose identities were not known. This had begun to cause some discomfort. Typically, PNs were issued by leading FIIs to investors abroad in lieu of shares bought on their behalf. These investors, mostly nameless and faceless, indirectly invested in derivatives based on Nifty and other equity options. SEBI and finance ministry clamped down on them in October 2007 and told the registered FIIs to wind down their exposure on the PN account to no more than 40% of their total investments by March 2009.

So the idea, clearly, was to make the FII investment regime more transparent. That objective remains quite as valid today. In fact, SEBI has through these restrictions managed to get many big institutional investors to register directly with the regulator rather than invest incognito through participatory notes. The government is looking at relaxing the PN regime only because portfolio flows have dried up following the mayhem on Wall Street. The proposal, it appears, is to extend the time limit for the FIIs to unwind their excess PN exposure. It can possibly be justified as a temporary measure aimed at improving market sentiment. However, SEBI must not lose sight of its larger objective of maintaining transparency in the FII investment regime. For, the extended time limit given to the FIIs to unwind their PN investments could prove redundant as they may reduce their exposure much faster, triggered by big investment banks on Wall Street deleveraging their derivative positions over the next few months.

Source: Economic Times

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