Sebi's P-note derivative ban fails to dent Indian futures market volumes

Average daily F&O turnover has increased 20 per cent despite curbs imposed by Sebi six months ago

It has been six months since market regulator Securities and Exchange Board of India’s (Sebi’s) diktat of not allowing participatory notes (p-notes) to take unhedged positions in Indian derivative markets took effect. Contrary to industry concerns at the time the decision was taken, however, the volumes in Indian futures market have only increased since August 2017.

According to data compiled from stock exchanges, the average daily turnover of Indian derivative markets increased 20 per cent to Rs 84.3 billion in February 2018 billion from Rs 70 billion in August.

Market participants say, while there was some initial knee-jerk reaction due to the Sebi decision, the bull-run in the Indian markets helped negate the loss. Between August and September, the average daily turnover fell by about 10 per cent, or Rs 5,641 billion, as hundreds of P-note subscribers were forced to close their open positions. However, during this period, India was also one of the best-performing global markets, attracting more money in the segment.

“Initially, there was some nervousness in the market about Sebi’s decision. At that time, P-notes were holding open positions worth Rs 500 billion. There were fears of a liquidity crunch, as all of these investors would unwind their positions together. However, as our markets were doing well, the crisis was averted,” said a source.

Interestingly, the move didn’t even lead to a mass exit of foreign institutions from Indian markets. In fact, the bulk of P-note subscribers are learnt to have directly registered with Sebi as foreign portfolio investors (FPIs) since the ban. According to Sebi data, the number of FPIs increased to 9,042 in January 2018 from 7,807 in August 2017.

After tightening the p-note norms, Sebi also relaxed the FPI registration norms to make direct registrations easier for foreign funds. The regulator rationalised the ‘fit and proper’ criterion for FPIs and also relaxed the requirements for broad-based funds falling under Category-II FPIs – a long-standing industry demand.

Sebi is also trying to bring further relaxations for direct participation. Currently, it is working along the government to provide single-window clearance to FPIs. Foreign investors now fill at least six forms for a registration and the average time taken for the registration is about two months. Under single-window clearance, an overseas fund willing to register with Sebi has to fill a single three-page form and the registration timeline comes down to 10 days.

Nevertheless, this Sebi decision to ban P-note users from taking naked positions in the derivative market was the last nail in the coffin for the instrument. The total share of P-notes in FPI instruments fell to a multi-year low of 3.8 per cent in August, against 4.2 per cent in June. Ever since, the demand for p-notes has further dwindled, and they now account for only 3.4 per cent of the total FPI investments. Also, the notional value of P-notes in derivatives has collapsed from Rs 324.5 billion in June 2017 to Rs 30.84 billion in January 2017.

P-notes, which are also known as offshore derivative instruments (ODIs) are a means for overseas investors to invest in Indian markets without directly registering with Sebi. These instruments were popular in the initial years as there was no compliance burden and a complete anonymity was maintained for P-note subscribers. In 2008, they accounted for about half the total FPI inflows. However, the regulator tightened the framework around P-notes following concerns that the route was being misused for laundering money. Experts say, p-notes these days are used only by those foreign funds whose exposure to Indian markets is negligible.