Sebi might ease stand against p-notes in derivatives market

The Securities and Exchange Board of India (Sebi) is likely to take a less stringent approach in banning participatory notes (p-notes) from the derivatives market.


According to sources, the regulator may not stick to the pure definition of hedging and allow cross-sectoral bets.


Last month, Sebi had proposed to ban p-notes from taking naked positions in the derivatives segment. This means a p-note investor will be allowed to deal in the derivatives counter of a stock, say Reliance Industries, only if the investor owns the underlying stock in the cash segment.

The proposal faced opposition from foreign investors, who made representations to the markets regulator expressing concerns about the move. Sebi is likely to take a final call at its board meeting on Wednesday.


Sources say Sebi could give more leeway deciding what construes hedging. For instance, an investor with exposure to high-beta banking stocks can be allowed to go short on defensive bets such as consumer goods or in technology. Although hedging typically means going long and short on the same stock or sector, some investors use advanced strategies for minimising risks. “Numerous industry bodies, including FII (foreign institutional investor) lobbies, have expressed concerns about imposing a blanket ban on naked positions. They have explained cross-sectoral hedges are a prominent part of strategies globally to minimise risk. Hence, the regulator should give some leeway. Sebi has assured it will consider the issue,” said a source.


However, the regulator is unlikely to give any relaxations when it comes to cross-country hedging. In this strategy, investors buy shares of a country to minimise the risk that could arise due to their exposure to a different country. For instance, investors who are long on China could go short on India for hedging.


This proposal was floated by Sebi to curb speculative trading, which could increase volatility in the markets. Sebi had floated a discussion paper on p-notes last month which also included the proposal to levy $1,000 on each offshore derivative instrument (ODI) subscriber.


The Alternative Investment Management Association (Aima), the global representative of hedge fund sector, has written to Sebi that its proposals could kill liquidity in the Indian markets.


“We are concerned that Sebi’s proposal would negatively impact the ODI futures market and have unintended consequences for Indian capital markets. In particular, we envisage that a number of key informed investors would leave the market and this will reduce liquidity and affect accurate price formation,” said Aima in the letter.


The organisation added that p-notes as an instrument should not be discouraged by Sebi as it would be unviable for each and every portfolio manager to comply with the full foreign portfolio investor (FPI) regime in all circumstances in which an exposure to an Indian futures contract is sought.


Another global investor lobby, Asia Securities Industry and Financial Markets Association (Asifma), too is said to have written to Sebi on the issue. The weightage of p-notes has come down drastically in the last decade due to tightening of rules and increasing compliance. The proportion of p-notes to total FPI investments had come down to 6 per cent in April, compared to nearly 50 per cent a decade ago.


“P-notes have been impacted largely by two factors. The compliance burden has increased significantly on the p-note subscribers. On the other hand, FPI registration process has been simplified to a large extent making direct participation easier. However, the instruments are unlikely to phase out as investors who prefer taking small exposure to the country will still prefer p-notes over direct participation,” said Sudhir Bassi, partner, Khaitan & Co.

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