maverick
11-11-2007, 07:34 PM
From its peak the Mumbai stock exchange has lost 1000 points, a simple average of 250 points a day including the first Black Diwali in 7 years. But who knows, we may drop all the way down to 15,000 but the tarnished money will be out of the system-creating yet another investment opportunity for savvy investors to Buy stocks on the cheap.
In one stone, the Govt has hit several targets.
1. The restriction on P-notes and liberalisation of FII registration norms is a conscious effort at providing a greater level of transparency and regulation in the market place. This is certainly positive for the long term health of the market. Investor confidence will be boosted. But there will likely be short term pain.
2. By effectively restricting incremental inflows thorugh the P-note route, the Govt. has sought to temper the pace of the forex inflows into the country which could have grown by leaps and bounds but for the restrictions now imposed.
Surging inflows - whether it is from FIIs or from Migrant remittances - have been the root cause of Rupee appreciation,
Excess Liquidity, Asset Bubble and Inflationary pressures, apart from social problems due to disparity in Incomes.
3. By encouraging the eligible P-note investors to come as FII's the Govt has not only ensured the quality of inflows but also made it possible to earn Short Term Capital Gains tax of 10%. (Currently, the Pnote guys do not pay short term capital gains tax as the instrument is structured via Mauritius).
4. By insisting that only Regulated entities (not just Registered) are eligible for FII registration/ issue of Pnotes, the Govt has made it difficult for unregulated hedge funds to participate in the Indian market.
At the same time, the Govt. has been fair to Regulated Hedge Funds. The FII registration rules have been liberalised to
help them get in. The "broad-based" fund rule has been eased. Now it will include entities with at least 20 investors (this should be acceptable to hedge funds who tend to have small number of investors) with single investor holding a max 49% stake (from 10% earlier). Even the new funds (provided they are regulated) wanting to register now need to have a fund manager with at least one year track record (as opposed to the fund having track record of one year).
5. Paving way for Pension Funds entry
By paving way for Pension Funds, Foundations, University Funds, Endowments & Charitable Trusts to register as FII's
(eventhough they are not regulated), the Govt. has sent a signal to the global investor community that it is fair.
NET-NET: The P-note proposals are negative for Unregulated Hedge Funds, who are likely to find it extremely difficult to get fresh exposure to Indian market. They may flock to GDR/ADR markets, where premia may expand. There is need for clarity from the Regulator on whether the ceiling on AUC as per the prescribed formula for Pnote issuance is dynamic, ie. whether it moves up if the market moves up, and if it doesn't whether there is need for unwinding.
The Volumes in Derivatives market is expected to come down in the short term due to ban on fresh issue of Pnotes with Derivatives as underlying. This will reduce the arbitrage activities by FII's between the cash market and derivatives market. This, coupled with the limit restrictions on fresh issue of Pnotes with Equities as underlying will impact the volumes and liquidity in the cash market.
There is no data readily available as to how much of the Pnote oustandings are accounted for by Unregulated Hedge Funds. Much depends on the view they take, i.e whether they will stay put with their long positions (and not sell) to keep their India exposure intact, or whether they would switch to ADRs/GDRs (where premium expansion is likely).
At the point of writing, Sensex is up 470 points or 2.53%. Which means, the market has not accepted the reality that the fresh inflow of funds through the Pnote route (that was the driving force for the big rally since Fed rate cut) is now virtually gone. Liquidity is the lifeblood of a rally. If that is restricted, the logic demands that the market should correct.
One interesting part of SEBI's guidelines on Pnotes is that the P-note issuing FIIs whose Pnote exposure is more than 40% of the AUCs as on Sept 30, are not required to unwind it down to 40%. This cut off date is only relevant for those whose exposure is less than 40% so that they can issue incremental 5% Pnotes. So, there was every reason for the P-note providers (whose exposure was more than 40%) to aggressively ramp up their Pnote positions further to the hilt by actively advising their Hedge Fund clients to buy before they could not. In other words, they could freely buy till yesterday. In my view, it was the Pnote inflow that was driving the market rally in the recent weeks. From today, the Pnote inflow should thin down signficantly. When this realisation sinks in the minds of the investors, the market should
start correcting, in my view.
Valuations are not supportive. Oil is at $ 91.49. There is political uncertainty on the horizon. I think, one should start
taking some profits. Before the rush begins.And re-enter after a meaningful 10-15% kind of correction.
HIGHLIGHTS OF SEBI'S PNOTE PROPOSALS
> SEBI's P-note guidelines are mostly in line with draft proposals.
> What's new is that: It has dealt a blow to unregulated hedge funds. Entities that are not regulated in their own home country will neither be granted FII registration nor will be issued fresh P-notes/Offshore derivative instrument (where underlying is cash equity). The exception to this rule are Pension Funds, Foundations, University Funds, Endlowment & Charitable Trusts who are eligible for the FII registration eventhough they may not be Regulated in their home country.
MOST HEDGE FUNDS - ESPECIALLY THOSE BASED IN THE U.S. - ARE BELIEVED TO BE UNREGULATED (EVENTHOUGH THEY MAY BE REGISTERED) AND HENCE THEY WILL GET HURT MOST BY THE SEBI GUIDELINES.
> They may flock to Indian GDR/ADRs which will now become a precious commodity.The GDR/ADR premia may expand. This may prompt some regular FII's to switch from local to ADR/GDR to take advantage of the premium expansion.
> But there are some relaxations in the FII Registration norms:
i) The "Broadbased" fund rule has been eased. Now it will include entities with at least 20 investors, with a single investor holding a max 49% stake (from 10% earlier). This facilitates entry of Hedge Funds with high-networth individuals as underlying investors as FIIs, provided such Funds are Regulated in their home country.
ii) New Funds wanting to register need to have a fund manager with at least a one-year track record (earlier the Fund needed to have a one year track record).
SEBI RULES IN NUT-SHELL
1) P-notes/Offshore Derivative Instruments (ODI's) cannot be issued where the underlying is derivatives.
2) Current position (where underlying is derivatives) to be wound up in 18 months,
3) FII sub-a/cs cannot issue P-notes. They will have to register themselves as FII's. Both proprietary and corporate sub accounts can register as FII's. They can continue to do the business as normal till a decision is taken on their application for Registratin as an FII. These sub accounts have already applied for registration as FII's.
4) The FII's whose P-note exposure (with underlying as equity) is 40% or more of their total Assets Under Custody (AUC) as on Sept 30, 2007 need to cap at that level. Please note that if the exposure is more than 40%, they need not wind it down to 40% (this probably explains the sudden rush of Pnote buying that we witnessed in recent weeks).
In the above case, these entities can issue further Pnotes only against cancellation/ redemption/ closing out of the existing P-notes of at least equivalent amount.
Here clarity is required on the question: Does the ceiling of the AUC as per above formula move up on a dynamic basis if the market moves up? If that is not the case, then there may be need for unwinding the Pnotes whenever the AUC moves up because of market going up.
5) The FII's whose P-note exposure (with underlying as equity) is less than 40%, they can issue further P-notes/ODIs at the incremental rate of 5% of their AUC in India.
6) No separate rules for IPO applications through P-notes. In other words, the limit restrictions on Pnotes are inclusive
of IPO. Clarity is required here whether the restriction is even for the IPO application amount or only the allotment
In one stone, the Govt has hit several targets.
1. The restriction on P-notes and liberalisation of FII registration norms is a conscious effort at providing a greater level of transparency and regulation in the market place. This is certainly positive for the long term health of the market. Investor confidence will be boosted. But there will likely be short term pain.
2. By effectively restricting incremental inflows thorugh the P-note route, the Govt. has sought to temper the pace of the forex inflows into the country which could have grown by leaps and bounds but for the restrictions now imposed.
Surging inflows - whether it is from FIIs or from Migrant remittances - have been the root cause of Rupee appreciation,
Excess Liquidity, Asset Bubble and Inflationary pressures, apart from social problems due to disparity in Incomes.
3. By encouraging the eligible P-note investors to come as FII's the Govt has not only ensured the quality of inflows but also made it possible to earn Short Term Capital Gains tax of 10%. (Currently, the Pnote guys do not pay short term capital gains tax as the instrument is structured via Mauritius).
4. By insisting that only Regulated entities (not just Registered) are eligible for FII registration/ issue of Pnotes, the Govt has made it difficult for unregulated hedge funds to participate in the Indian market.
At the same time, the Govt. has been fair to Regulated Hedge Funds. The FII registration rules have been liberalised to
help them get in. The "broad-based" fund rule has been eased. Now it will include entities with at least 20 investors (this should be acceptable to hedge funds who tend to have small number of investors) with single investor holding a max 49% stake (from 10% earlier). Even the new funds (provided they are regulated) wanting to register now need to have a fund manager with at least one year track record (as opposed to the fund having track record of one year).
5. Paving way for Pension Funds entry
By paving way for Pension Funds, Foundations, University Funds, Endowments & Charitable Trusts to register as FII's
(eventhough they are not regulated), the Govt. has sent a signal to the global investor community that it is fair.
NET-NET: The P-note proposals are negative for Unregulated Hedge Funds, who are likely to find it extremely difficult to get fresh exposure to Indian market. They may flock to GDR/ADR markets, where premia may expand. There is need for clarity from the Regulator on whether the ceiling on AUC as per the prescribed formula for Pnote issuance is dynamic, ie. whether it moves up if the market moves up, and if it doesn't whether there is need for unwinding.
The Volumes in Derivatives market is expected to come down in the short term due to ban on fresh issue of Pnotes with Derivatives as underlying. This will reduce the arbitrage activities by FII's between the cash market and derivatives market. This, coupled with the limit restrictions on fresh issue of Pnotes with Equities as underlying will impact the volumes and liquidity in the cash market.
There is no data readily available as to how much of the Pnote oustandings are accounted for by Unregulated Hedge Funds. Much depends on the view they take, i.e whether they will stay put with their long positions (and not sell) to keep their India exposure intact, or whether they would switch to ADRs/GDRs (where premium expansion is likely).
At the point of writing, Sensex is up 470 points or 2.53%. Which means, the market has not accepted the reality that the fresh inflow of funds through the Pnote route (that was the driving force for the big rally since Fed rate cut) is now virtually gone. Liquidity is the lifeblood of a rally. If that is restricted, the logic demands that the market should correct.
One interesting part of SEBI's guidelines on Pnotes is that the P-note issuing FIIs whose Pnote exposure is more than 40% of the AUCs as on Sept 30, are not required to unwind it down to 40%. This cut off date is only relevant for those whose exposure is less than 40% so that they can issue incremental 5% Pnotes. So, there was every reason for the P-note providers (whose exposure was more than 40%) to aggressively ramp up their Pnote positions further to the hilt by actively advising their Hedge Fund clients to buy before they could not. In other words, they could freely buy till yesterday. In my view, it was the Pnote inflow that was driving the market rally in the recent weeks. From today, the Pnote inflow should thin down signficantly. When this realisation sinks in the minds of the investors, the market should
start correcting, in my view.
Valuations are not supportive. Oil is at $ 91.49. There is political uncertainty on the horizon. I think, one should start
taking some profits. Before the rush begins.And re-enter after a meaningful 10-15% kind of correction.
HIGHLIGHTS OF SEBI'S PNOTE PROPOSALS
> SEBI's P-note guidelines are mostly in line with draft proposals.
> What's new is that: It has dealt a blow to unregulated hedge funds. Entities that are not regulated in their own home country will neither be granted FII registration nor will be issued fresh P-notes/Offshore derivative instrument (where underlying is cash equity). The exception to this rule are Pension Funds, Foundations, University Funds, Endlowment & Charitable Trusts who are eligible for the FII registration eventhough they may not be Regulated in their home country.
MOST HEDGE FUNDS - ESPECIALLY THOSE BASED IN THE U.S. - ARE BELIEVED TO BE UNREGULATED (EVENTHOUGH THEY MAY BE REGISTERED) AND HENCE THEY WILL GET HURT MOST BY THE SEBI GUIDELINES.
> They may flock to Indian GDR/ADRs which will now become a precious commodity.The GDR/ADR premia may expand. This may prompt some regular FII's to switch from local to ADR/GDR to take advantage of the premium expansion.
> But there are some relaxations in the FII Registration norms:
i) The "Broadbased" fund rule has been eased. Now it will include entities with at least 20 investors, with a single investor holding a max 49% stake (from 10% earlier). This facilitates entry of Hedge Funds with high-networth individuals as underlying investors as FIIs, provided such Funds are Regulated in their home country.
ii) New Funds wanting to register need to have a fund manager with at least a one-year track record (earlier the Fund needed to have a one year track record).
SEBI RULES IN NUT-SHELL
1) P-notes/Offshore Derivative Instruments (ODI's) cannot be issued where the underlying is derivatives.
2) Current position (where underlying is derivatives) to be wound up in 18 months,
3) FII sub-a/cs cannot issue P-notes. They will have to register themselves as FII's. Both proprietary and corporate sub accounts can register as FII's. They can continue to do the business as normal till a decision is taken on their application for Registratin as an FII. These sub accounts have already applied for registration as FII's.
4) The FII's whose P-note exposure (with underlying as equity) is 40% or more of their total Assets Under Custody (AUC) as on Sept 30, 2007 need to cap at that level. Please note that if the exposure is more than 40%, they need not wind it down to 40% (this probably explains the sudden rush of Pnote buying that we witnessed in recent weeks).
In the above case, these entities can issue further Pnotes only against cancellation/ redemption/ closing out of the existing P-notes of at least equivalent amount.
Here clarity is required on the question: Does the ceiling of the AUC as per above formula move up on a dynamic basis if the market moves up? If that is not the case, then there may be need for unwinding the Pnotes whenever the AUC moves up because of market going up.
5) The FII's whose P-note exposure (with underlying as equity) is less than 40%, they can issue further P-notes/ODIs at the incremental rate of 5% of their AUC in India.
6) No separate rules for IPO applications through P-notes. In other words, the limit restrictions on Pnotes are inclusive
of IPO. Clarity is required here whether the restriction is even for the IPO application amount or only the allotment