Participatory notes with underlying Indian securities

The Securities and Exchange Board of India ("SEBI") has decided to amend its draft code of conduct governing market participants so as to lift the proposed prohibition on Foreign Institutional Investors ("FIIs") from dealing, either directly or indirectly, in any derivative instruments (e.g. participatory notes) issued outside India where the underlying securities are Indian securities. The decision seems to have come in wake of protests from FIIs and foreign brokerage firms who contended that Sebi did not have any jurisdiction over such instruments issued outside India. The significance of this amendment would mean that SEBI will recognise the participatory notes issued by registered FIIs or foreign brokers, provided they comply with the adequate disclosure standards.

Participatory notes are issued by domestic institutional brokerages to foreign individuals and institutional investors where the underlying assets are securities listed on the Indian bourses. FIIs who do not wish to register with the SEBI but would like to take exposure in Indian securities also use the participatory notes. Brokers buy or sell securities on behalf of their clients on their proprietary account and issue such notes in favour of such foreign investors.

Market players estimate that close to US $1.5bn of outstanding foreign institutional investment has been made through participatory notes. The total FII investment till date is US $17.7bn. Over the past seven months, FIIs have reported net inflows of over US $2.5bn with a third of this investment being through the participatory note route.

Source: The Economic Times, July 25, 2003.