India Looks to Shed Light on Foreign Investments

Indian markets were on a wild ride today, dropping around 10% minutes after they opened but recovering to close down just 1.8% or so.

The culprit for that volatility was news after Tuesday's close in India that market watchdog the Securities Exchange Bureau of India (SEBI) was going to ban Participatory Notes, or PNs, in order to cool off the massive amount of foreign capital going into Indian markets.

Foreign Institutional Investors (FIIs) have poured almost $19 billion into Indian stock markets this year, shattering the prior record of $10.5 billion in 2005. Since the Fed cut rates here, almost $5 billion in new foreign capital has poured into Indian equities, leading to a sharp rise in the rupee.

So, what exactly are PNs, or P-notes as they are also known?

• Only FIIs who are registered with SEBI can buy and sell Indian shares and derivative instruments. As of Oct. 16, there were 1,113 registered FIIs.
• P-notes are financial instruments used by foreign investors -- such as hedge funds, institutions and brokerages -- that are not registered with SEBI but still want exposure to Indian stocks.
• A registered FII buys or sells Indian shares for a client through a sub-account and issues the client P-notes equal to the value of the underlying investment. FIIs settle the trade internally, without having to reveal the clients' identities.
• The number of FIIs issuing P-notes more than doubled to 34 as of August 2007 from 14 in March 2007, according to SEBI.
• The value of P-notes rose to more than 3 trillion rupees (almost $90 billion) as of August 2007 from 319 billion rupees (just under $10 billion) in March 2007.

After the markets plunged this morning, SEBI shut down trading for an hour and issued a clarification stating that it was not banning PNs altogether, but rather limiting the investment horizon to 18 months.

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Jay Somaney is a partner and fund manager with TSG Capital Partners, a hedge fund based in Plano, Texas, and founder of GlobalTechStocks.com. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Somaney appreciates your feedback; click here to send him an email.