Participatory Notes are financial instruments used by investors or hedge funds that are not registered with the Securities and Exchange Board of India to invest in Indian securities. Indian-based brokerages buy India-based securities and then issue participatory notes to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the investors. In many ways, this is similar to an informal ADR process, where brokerages hold on to stocks for foreign investors. However, Indian regulators are not very happy about participatory notes because they have no way to know who owns the underlying securities. Regulators fear that hedge funds acting through participatory notes will cause economic volatility in India's exchanges. Many market participants believe that PNs are bad because they are unregulated. Some key brokers have said the market for P-Notes may become as big a market as the regulated exchanges — BSE and NSE — and end up dictating prices from outside. There is a reason to believe they will not. Despite the huge growth of P-Notes, the Indian markets remain fundamentally stronger and more efficient compared to almost all other emerging markets. That gives it the power to determine prices of stocks, without being influenced by parallel markets. In this entire hullabaloo over P-Notes, this is a fact that has somehow gone unnoticed.   more »

World over, money moves fast through markets thanks to hedge funds. In India, authorities are scared to allow these absolute-return creatures — dubbed ‘Masters of the Universe’ — because of the clout they wield. The government has till now preferred foreign investor participation through the participatory notes route. A source working for a foreign institutional investor told DNA Money that Sebi should at least allow hedge fund money to come in now or the market will be on weak legs. Hedge funds and PNs come in only to benefit from the leverage opportunity available in the derivatives segment. It will thus be prudent to quickly legalise hedge funds, treat them as FIIs and get the money back into the country. Prima facie, the Sebi proposals are to plug two loopholes — thwart hot money, and know the identity of the investor. The last time such a move was hinted at — on January 20, 2004 — the market fell a total 8% in three days to January 22, only to recover most of it in the next two after the government clarification came. (DNA India)   more »

SEBI has suggested that foreign institutional investors should be barred from issuing or renewing offshore derivative instruments linked to the futures and options markets. Offshore investors would be required to extinguish existing participatory notes linked to them in 18 months, the regulator said. It has sought a response to the proposals by Oct. 20. Offshore instruments such as participatory notes, known as P-Notes, are derivatives that are sold by brokers to investors who aren't registered with India's stocks regulator. The value of the notes are based on the underlying stocks. More than half of the $17 billion of flows into Indian stocks this year may have been through the use of the so-called participatory notes, JPMorgan Chase & Co. wrote in a research report today. The notes, which change in value depending on the performance of the underlying securities, provide hedge funds anonymity in their investments. The notional value of participatory notes outstanding increased 11-fold to 3.53 trillion rupees ($89.8 billion) as of August this year from 318.8 billion rupees in March 2004, the regulator said. ( Bloomberg)   more »