-
Participatory notes -
how will the markets react ?
- Was the huge rally
on Friday justified ?
The last week has seen extreme volatility
ever since a leading pink paper reported that SEBI was considering banning
p/notes ( participatory notes ) for FII's. What are these instruments and
how will the markets react to the latest developments ? We try to clarify
the issue below -
P/N's - what they are ?
participatory notes are an indirect
exposure to the underlying securities which are issued by FII's to other
FII's. When you buy a stock future, you are taking a position on the
underlying equity shares, without ever buying those shares in physical
form. Since un-registered FII's cannot buy equities in India, they take
exposure through the registered FII's in this indirect fashion. SEBI
regulations are applicable only to the registered FII's and the P/N's are
therefore often into un-registered hands ( read that as hedge funds ).
P/N's totalled about Rs 20,000 crs or approximately 25 % of FII inflows.
SEBI was reportedly aiming to rectify that.
What has SEBI done now ?
SEBI has stopped fresh issue of P/N's after
Feb 03, 2004 to unregistered FII's. The existing notes will be invalid
after 5 years or be wound up ( expire ) on their tenure day, whichever is
earlier. Since un-registered FII's cannot take the P/N route, hedge funds
will be effectively halted from investing in equities. This is expected to
give greater control to the regulators in knowing where the inflows are
coming from. The P/N's are to be issued by FII's only after the KYC ( know
your client ) documents are completed, therefore enabling SEBI to
ascertain the last mile source of funds. Effectively, all fresh
inflows of un-registered nature are blocked, whereas the existing funds
can remain invested.
The effect on the markets
The markets have reacted a little too
euphorically in my opinion. The market players have assumed that P/N's
will not be banned and all is hunky dory. Once the finer print is
digested, we feel the mood maybe somewhat sombre. In the near term, there
maybe a higher degree of volatility and the market players maybe cautious,
however, we feel the longer term effects are likely to be highly positive.
It is important that the future rally be built on a solid foundation with
long term funds and not just opportunistic players. This fact will take a
few days to sink in and till then, the markets will consolidate. We
feel this is a very mature step by SEBI - for larger benefits.
Look before you leap on
Tuesday ( Jan 27, 2004 ) and avoid buying left right and centre. We feel
investors should await the expiry of the January series before taking a
fresh view on the markets. The worst is clearly over in terms of
downsides. We do not see any fresh crash.
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Have a profitable
day.
- Vijay L Bhambwani
The author is
a Mumbai based investment consultant and
invites feedback at Vijay@BSPLindia.com
and ( 022 ) 23438482 / 23400345.
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