All That Glitters Is Not FII Money

It is a thumb rule now in India that if you have to invest in equities then you must invest in those scrips in which FIIs have parked their money. It is considered as a guarantee for the upsurge of the underlying stocks in the coming days or months. Retail investors, especially so, usually look at this factor with a lot of enthusiasm to take chances with this section of the capital market. But it involves huge risks as the money which is supposed to be from foreign institutions could well be money from the pockets of the promoter of that company, routed through P Notes into the markets and ‘tagged’ as FII investments. There is no denying the fact that FII inflows into the Indian stock markets have improved a lot and in the past seven months they infused around Rs 35,369 crore with a larger chunk coming through in the last three months i.e. May onwards. In July alone FII has pushed Rs 11,066 crore into the markets and in June they have complemented their investment with another Rs 3,830 crore. Considering the present state of the world’s finance infrastructure it is very difficult to digest the fact that all the unabated money which is coming into India belongs, in reality, to these financial institutions. Experts are of the opinion that a major part of this money could be of Indian origin which is being invested here through this channel via sub-accounts of giant financial institutions. These are popularly known as participatory notes or PNs.
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Unholy Association
Actually P Notes are instruments that are used by investors or hedge funds that are not registered in India with SEBI to invest in securities. India-based brokerages buy Indian securities and then issue PNs to foreign investors. Any dividends or capital gains collected from the underlying securities go back to the foreign investors. As is known, FIIs and their sub-accounts make use of this instrument just to facilitate the participation of their overseas clients. Nowadays, investment and trading through PNs is very easy as they are like contract notes transferable by endorsement and delivery. Due to this benefit, lots of Indian promoters are routing their investment through PNs to take advantage of the tax laws of certain preferred countries.

“Lots of promoters want to paint a rosy picture about their FII share-holding to the investors, especially to the retail ones. For this, PNs are the best path available as they can make use of their own money to boost FII shareholding and for this they just have to have a operator-FII nexus,” states Ashish Maheshwari, Director, Globe Capital Markets. “Presently many of the funds operating in the markets are only into such activities and are earning 5-20 per cent of the total money routed. Also, this nexus primarily works in the small-cap and mid-cap categories,” he adds.

Beware Of Sub-Accounts
In this way, by routing funds from India the company management can easily shoot up their FII holding and innocent retail investors get trapped into this net as they only look out for the FII stake from the information available in the public domain but they don’t have that kind of expertise to segregate a genuine FII investment[PAGE BREAK]

from the routed one. Another interesting thing is that lots of sub-accounts of leading foreign institutions are now giving face to this nexus of operators and promoters because in the last one year, due to a liquidity crisis, these sub-accounts went into turmoil and were almost abandoned, making them a prized target for these type of operations.

Where’s The Pressure?
The government and SEBI are well aware of this process and because of this in October 2007 SEBI had [INSERT_2]

imposed restrictions on the issue of PNs in order to stem the fishy inflow of funds from overseas into the share markets. But in October 2008, SEBI was forced to backtrack on this issue due to the unprecedented financial crisis engulfing the globe. At that point it was a wise thing to do since SEBI and the government couldn’t afford to put pressure on an already strained market. “In the present global scenario it would be disastrous for the markets to put any curb on PNs and the government doesn’t want to carry the blame of unsettling an already vulnerable market condition,” Maheshwari points out.

The quantum of this inflow can be gauged from the fact that from January to May 2008 the total investment in Indian securities in the form of PNs ranged from 30-39 per cent of the total assets under the management of FIIs. Due to restrictions this investment went down gradually till December 2008 to touch 17.1 per cent but from January to July 2009 it showed some consistency with a range of 15.55 per cent to 17.7 per cent of the total assets under FII management. This totalled Rs 6,29,647 crore in June 2009 and there is no denying the fact that a large part of this is routed investment.

However, market forces are not at all bothered by these investments and don’t want to play spoilsport either. “This debate to cast a doubt on FII investment is not at all justified as a major part of the FII money is genuine with Indian markets presenting a marvellous opportunity for overseas investors. That is the reason why the confidence of FIIs is appreciating manifolds and they are channelising huge sums of money into the markets,” observes Chetan Gupta, COO, Money Vistas. Also it is very difficult to segregate genuine FII investment from the doubtful ones and so it is not at all possible for the government to put a curb on such dealings.