Sebi moderates capital flows.. Market Crashes!!

Last updated: 17 October 2007

In an attempt to slow FII inflows, capital market regulator Sebi on Tuesday proposed a complete ban on the issue of overseas derivatives instruments (ODIs) like participatory notes (PNs) and other papers with immediate effect.

Sebi also proposed a measure to reduce FII exposure in the derivatives market by suggesting that they and their sub-accounts not be allowed to issue or renew ODIs with underlying derivatives with immediate effect. Sebi has proposed giving 18 months to FIIs to wind up their current positions, during which it will review the situation.

These proposals are contained in a discussion paper posted on Sebi's website and open to public comment until October 20. According to sources, considering the urgency of the matter, this issue is expected to top the agenda of the next Sebi board meeting scheduled for October 25.

Sebi has also said that FIIs currently issuing ODIs with a notional value of PNs outstanding (excluding derivatives) as a percentage of their Assets Under Custody (AUC) in India of less than 40% would be allowed to issue further ODIs only at an incremental rate of 5% of their AUC in India.

Sebi said the rise in ODIs, the comfort it gave issuers and the copious inflows by foreign investors had engaged the government's attention as well as that of regulators like Sebi and RBI.

PNs have risen significantly in the last three years, both in terms of the number of issuers and investments.

Reacting to the development, UK Sinha, CMD, UTI MF, said, "It's a positive step by the regulator to control the froth of liquidity that we have been witnessing in the market. Every nation needs to know what type of money is coming in. Since the regulator has given a reasonable time to FIIs and sub-accounts to wind up their positions, we expect an orderly impact on the market."

In March 2004, there were 14 FIIs and sub-accounts that issued PNs, and the notional value of PNs outstanding was Rs 31,875 crore, which was 20% of the total AUC at that time. In August 2007, the number of FIIs and sub-accounts issuing PNs increased to 34 and the value of outstanding ODIs with underlying derivatives stood at Rs 1,17,071 crore. This is approximately 30% of total PNs outstanding. The notional value of outstanding PNs, excluding derivatives as underlying, as a percentage of AUC is 34.5%.

Of the total market-wide open interest of over Rs 1 lakh crore in the derivatives segment as on Monday, FIIs hold 35.98% of the net outstanding position. Of this, FIIs have exposure of more than 50% in individual stock futures, which also includes arbitrage positions and 27% exposure in index futures.

A fund manager, who did not wish to be named, said, "Markets will react severely.

The regulator has taken the right move to control the overheating in the market. When a FII invests in the Indian market, it first buys futures of the company and then buys the stock, which leads to overheating."

Market experts feel that Sebi's proposed move would certainly cap the current bull rally. Derivatives experts fear that since most positions in the derivatives segment are long, the unwinding of these positions could see a sharp correction on the market. The proposed move by the regulator is seen as welcome, as its implementation would ensure that new exposure in the Indian markets is through stable and accountable money.

Vijay Mantri, CEO, Deutsche Asset Management Company, said, "In order to control the ample liquidity and ensure that the market develops in an orderly manner, the regulator has come out with this proposal. There might be a short-term blip in the market; we still have to wait and watch how FIIs react."

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Sebi moderates capital flows.. Market Crashes!!

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