P- Notes, cause of the bearish sensex

What are Participatory notes?




P-Notes are instruments issued contractually by FIIs to third parties reflecting ownership of the economic benefits of specified underlying Indian securities. P-Notes conventionally come into being through the execution of an over-the-counter derivative contract* between the P-Note holder and the FII. Through a P-Note, the counterparty of the FII could acquire an exposure to the value of the economic benefits holding the underlying securities without the legal benefits such as voting power. An FII could well issue a P-Note without holding the underlying securities, if it does not care to hedge its exposure. However, as any prudent person would, an FII would hedge its obligations owed to the P-Note holder by either holding the underlying securities, or by hedging the exposure on the futures and options segment in India.




Why was this new P- notes policy proposed?




1. RBI was always against the use of P-notes. The reason being that it was difficult to know the source of the FII funds that flow into India.
2. Due to this flow it was difficult to control the inflow of dollar and hence rupee appreciation.
3. It is believed that private banking coffers of Indian-resident politicians and industrialists held offshore, is the source of investments through the P-Note route.
4. Intelligence agencies had warned the government that terrorist funds too are benefiting from the exponential upsurge in Indian stock prices using the P-Note route.




What is the new policy?




5. First, P-Note exposures leveraging on the exposure in India, to the futures and options segment, are sought to be banned.
6. Second, it is proposed that FIIs alone ought to issue P-Notes and not their sub-accounts. Sub-accounts are entities registered as such under the aegis of the registration of any FII, which route too permits a foreign person to invest into the Indian market.
7. Third, the size of exposure an FII could provide its clients through P-Notes is sought to be curtailed through a quota system.

*Over-the-counter (OTC) derivatives are contracts that are traded (and privately negotiated) directly between two parties, without going through an exchange or other intermediary. Products such as swaps, forward rate agreements, and exotic options are almost always traded in this way.




I would like my more informed friends to carry on the discussion further. I have told about the causes they can contribute on the effects.

Source: Business Standard