Investments through participatory notes, which have been hovering at around 14 per cent of the assets under management of foreign institutional investors for the last few months, are set to see a sharp spike when the market regulator announces the final figures for October.
Reason: the Coal India issue. Sources familiar with the developments said nearly Rs 72,000 crore (Rs 720 billion), or 40 per cent of the total applications for the qualified institutional buyers' quota in the issue, have come through the PN route.
Investment banking sources said players with leveraged positions widely used this instrument.
Even several foreign investors disallowed from investing in the market for failing to comply with regulatory norms have been using the PN route.
Investments through PNs as a percentage of total FII investments had dipped to 13 per cent in September. But that was because of the overall surge in FII fund flows into India.
In absolute terms, PN investments went up by 25 per cent to Rs 2,00,927 crore (Rs 2,009.27 billion).
October will see a spike in both the numbers, the sources said.
Market participants expect a large part of refunds from the Coal India issue to stay in India, and that includes money that came through PNs.
A PN is an offshore derivative instrument, wherein overseas investors get a letter from brokers mentioning transactions made on their behalf.
The instrument generally helps investors protect their identity.
Observers said Indian regulations compel foreign institutional investors to put up 100 per cent of the money along with an application.
Therefore, many take the leverage route -- hence, the PN route -- so that they can apply for a much higher quantity.
The surge in PNs, the sources said, puts many domestic institutions at a disadvantage as they have to be satisfied with lower subscription and, hence, allotment in high-profile
A leading domestic institutional investor said it is now time to bar PNs from IPOs.
Earlier this month, market regulator Securities and Exchange Board of India had disallowed 188 FIIs and 336 sub-accounts from investing in the Indian market for not being compliant with its specified holding structure.
"But several of these FIIs skirted the Sebi ruling by investing through the PN route," said an investment banker.
Siddharth Shah, head, corporate & securities, Nishith Desai Associates, said, "PNs have emerged an effective and efficient way of accessing the Indian capital market, as they provide flexibility in terms of product as well as funding. Entities failing to comply with Sebi directives may still be eligible to buy PNs."
However, he was not sure how Sebi or RBI would respond to the increased flow of funds through PNs. Sebi had earlier said an FII should not be treated as a 'protected entity'.
In June 2007, investments through PNs had risen to 55.7 per cent of assets under management of FIIs.
This prompted Sebi to place certain restrictions in October 2007, like barring FIIs from owning more than 40 per cent of their assets in PNs.
These were rolled back a year later.
To encourage direct participation of FIIs into the Indian market, Sebi made their registration simpler and processed their applications faster.
