FII holdings through P-notes rise

Large funds playing in the Indian stock market through off-shore derivative instruments (ODIs), known as participatory notes (P-notes), saw their holdings rise in August. Foreign institutional investor (FII) holding through participatory notes rose by 1.4 per cent in equities and debt instruments, including the derivatives segment last month.

FIIs’ P-notes positions stood at 15.4 per cent in August, compared to 14 per cent in the previous month, show data from the Securities and Exchange Board of India. This was at a time when registered FIIs sold stocks worth over Rs 10,000 crore in the equity segment onshore and the index fell by around 15 per cent, following the US debt downgrade by global ratings agency S&P. The downgrade and a negative outlook by S&P sent the global equity markets on a crash course.

Saurabh Mukherjea, head of equities, at Mumbai-based Ambit Capital, said: “The conventional long-only funds are retreating from India, while the hedge money is coming in. Quantitative easing has provided hedge funds with plenty of liquidity and that liquidity has made its way to riskier markets like India...hedge funds’ appetite remains healthy for India and hedge funds often take the P-note route for investing in India.”

U R Bhat, managing director, Dalton Capital Advisors, said: “August saw a lot of selling from India-dedicated funds that led to a fall in the total assets under management. It is possible that P-note holders, in the same period, held on to their share, thereby leading to an increase in the percentage.”

In August, the FII holding through P-notes in debt and equity, excluding derivatives, rose to 10.2 per cent in August from 9.6 per cent in July. Overall, FIIs hold stocks and debt instruments worth Rs 9,85,893 crore, or nearly $210 billion. Out of this, nearly Rs 1,50,000 crore worth of debt and equity instruments are held through P-notes.

P-notes are off shore derivative contracts whose holders do not want to bring money directly into India to avoid scrutiny. Institutions issuing these ‘hot money’ instruments are mainly registered in tax havens. Large players in this trade include Morgan Stanley, Citigroup, Goldman Sachs and CLSA. Somewhat similar are ETFs, in which large funds primarily put their money, making it difficult to track the ultimate beneficiary.

P-note positions had reached 60 per cent of FII investments in 2007, after which Sebi imposed a ban on their issuance. This was revoked by Sebi chairman C B Bhave in 2009. Sebi had also issued a circular asking FIIs to furnish more details and report P-note holdings with a six-month lag.

In 2008, FIIs were lending their P-note holdings overseas, which were used for short selling in India. Sebi had warned against the practice as short-selling played a significant role in bringing down the market in 2008. Currently, no domestic institution or portfolio manager is allowed to indulge in short-selling in the cash segment of the market.