Rational Advisor

17 Oct 2007 Financial Times of India
The government’s proposals, under which it wants to curb the use of offshore derivative instruments that allow foreign investors to trade anonymously in underlying Indian stocks, were packaged as a “discussion paper”. In reality, the document is infused with an urgency that suggests it could be implemented as early as next week.

“If the document is implemented as it is, it will be bad for the market. There will be more selling to come. But there is some feeling that there could be a bit of backtracking on the part of the authorities,” said Rajeev Malik, economist with JPMorgan.

Under the government’s proposals, foreign institutional investors would face tight restrictions on new issuance of the instruments, known as participatory notes or P-notes. In addition, a significant portion of those already in existence would be required to be wound up within 18 months

JPMorgan estimates the no­tional value of P-notes in the market at about $89.8bn (£44.1bn, €63.2bn) as of Au­gust this year, or nearly 52 per cent of assets controlled by foreign institutional in­vestors. This was more than 11 times greater than March 2004 levels.

The market for issuance is dominated by about 10 foreign investment banks and is believed to generate a total of about $200m-$300m for their bottom lines.

India’s market has risen 19.4 per cent since the US Fe­deral Reserve cut rates in mid-September, with much of the rise driven by an in­flux of money through P-notes.

Market participants said the move to wind down the P-note system was inevitable as India’s regulatory environment evolved to­wards global best practice.

“If we’re going to become a developed market, you need to know where all of these flows are coming from. Hot money flows are good for nobody,” said Tarun Kataria, managing director and head of corporate, investment banking and markets, India with HSBC in Mumbai.

Others say the government will need to improve procedures for registration for foreign investors to encourage them to come in the front door. The regulator only re­cently started allowing hedge funds to register and many remain reluctant to brave the red tape, which is time consuming and expensive.

There is also a widespread belief that many of the investors using P-notes are in fact the controlling shareholders of Indian companies who are playing their own stocks. (Rational - Insider trading, manipulation - why am I not surprised!!!)

Another group suspected of surreptitiously playing the market is Indian politicians, many of whom stash their wealth offshore. (Rational - again, why am I not surprised!! Corruption)

While exposing these scams will be good for governance, it might mean there will be less liquidity in the market in the near term. That could spell bad news for the great Indian bull-run over the next few months.

17 Oct 2007 07:17 BST From Financial Times: India’s financial markets plummeted at the start of trading on Wednesday after the stock exchange regulator moved to restrict foreign portfolio inflows of capital via offshore derivatives.

Trading in India was suspended for an hour three minutes after the open, following the breach of circuit triggers. Stocks are expected to fall further when markets reopen. The Nifty index plunged by 524.15 points, or 9.25 per cent, to 5143.90 while the BSE Sensex dropped by 1,507.71 points, or 7.91 per cent, to around 17,544.15 before trading was suspended.

The rupee fell to two-week lows, down 1.4 per cent to 39.88 against the dollar from Tuesday’s close. The market decline came after the Securities and Exchange Board of India on Tuesday night released a discussion paper proposing policy changes on offshore derivative instruments. Sebi’s proposed restrictions on the issuance of participatory notes to offshore investors would effectively plug an important source of equity inflows.

Thursday 18 Oct 2007 09:46 BST From Business Week online
Business Week reports: It was a shock for everyone playing the Indian stock market. On the evening of Oct. 16, the Securities and Exchange Board of India (SEBI) issued a statement on proposed policy changes. Worried about manipulation in a hot market, the regulator proposed to restrict the usage of offshore derivative instruments by foreign investors as a route to playing the Indian stock market. It gave investors till Oct. 20 to adapt to the new rules.

The suddenness of the decision took everyone by surprise, especially since billions in foreign money had entered India through these derivatives. When the market opened the next morning, Oct. 17, it fell almost immediately by 1,500 points or 9%—quite a switch from the day earlier when the Mumbai index closed at its all-time high of 19,000. The selling was so furious that trading had to be suspended shortly after the market opened. It was only after soothing statements by the regulator and the Indian finance minister, P. Chidambaram, that New Delhi did not mean the measures to be so harsh, and that they were awaiting market feedback on the changes, that trading could be resumed. The market climbed back up, to close at 18,633, down just 360 points in total.

From The Hindu Friday Oct 19
MUMBAI: The stock markets witnessed the biggest single day fall on Thursday as the Bombay Stock Exchange 30-share sensitive index (Sensex) lost 717.43 points at 17998.39. Metal, realty and bank stocks were the worst hit. On the National Stock Exchange (NSE) the 50-share Nifty also was down by 208.30 points at 5351.

The Participatory Notes (PNs) issued by the foreign institutional investors (FIIs) are still creating confusion in the stock market as the capital market regulator plans to impose a cap on the investments through this route, where the identity of the investor is unknown The heavy institutional selling took the indices to below the 18000-mark, which was achieved few days back.

Rationals thought - Although I don’t think this is the major drop, I do think we are close to it. Just think February, it was China, and now it’s India. These emerging markets volatilities are telling us something - Be careful.

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