SEBI curbs P-notes to boost transparency

India's stock market regulator tightened investment rules for unregistered foreigners as expected on Thursday by clamping down on issuance of indirect investment notes to stem inflows of anonymous money.

The Securities and Exchange Board of India (SEBI) said the new regulations on so-called participatory notes (P-notes) would come into effect at the close of trade on Thursday.

The regulator says P-notes allow foreigners to make a backdoor entry into the market without registering with Indian authorities and it wants them to register to create greater transparency on inflows.

"We are saying we are registering more FIIs. We are saying that we are fast-tracking the system of registration," SEBI Chairman M. Damodaran told a news conference after its board approved the new regulations.

"What we are doing is to clean up the regulatory environment, that is our terrain, rather than seek to do something else."

P-notes are issued by foreign institutional investors (FIIs) registered in India to unregistered overseas investors. Registered FIIs buy Indian securities and issue the notes based on the underlying asset.

The new rules follow the lines of a draft issued by SEBI last week.

FIIs and their sub-accounts -- vehicles set up by registered FIIs to issue P-notes -- are no longer allowed to issue P-notes whose underlying asset is a derivative.

"The related decision that the current position would be wound up over 18 months has also been approved by the board," Damodaran said.

Fresh issuance of other P-notes by sub-accounts would stop immediately and they would be required to wind up their current position over 18 months. However sub-accounts applying for FII status could continue business with their application pending.

SEBI also imposed a P-note issuance limit of 40 percent of assets under custody. Entities below 40 percent would be allowed an annual 5 percent incremental increase capped at 40 percent.

"But those who are going above 40 percent now had to stay where they are, and clearly those who are below 40 percent cannot be allowed to run away indefinitely," Damodaran said.

Other steps included allowing P-notes to be issued only to regulated entities.

Indian shares, which have been volatile since SEBI first made its plans public last week, ended up 1.4 percent ahead of the announcement, with investors optimistic the rules would largely be as the regulator had already outlined.

India, the world's fastest-growing major economy after China, has battled a surge of foreign capital this year, which has pushed the rupee to its strongest against the dollar since 1998 and helped power the stock market to a series of record highs.

The finance minister has said India is also trying to moderate inflows to avoid a stock market bubble.

Net foreign portfolio investments so far this year are more than $17 billion, well above the full-year record inflow of $10.7 billion in 2005.

More than $8 billion of foreign funds flowed in the weeks after the United States cut interest rates in mid-September, prompting SEBI to announce its plans.

Source - Reuters