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Commentary

FIIs : Unwind P-Notes Sold To Individuals Within One Year

After the big drama in October 2007, it seemed like FIIs were getting the short end of the stick. (I still think they created a big fuss out of nothing. The US SEC is far more restrictive for its own exchanges.)

Having dug out the details in the SEBI FII Regulations (Section 15A):

A Foreign Institutional Investor or sub account may issue, deal in or hold, off-shore derivative instruments such as Participatory Notes, Equity Linked Notes or any other similar instruments against underlying securities, listed or proposed to be listed on any stock exchange in India, only in favour of those entities which are regulated by any relevant regulatory authority in the countries of their incorporation or establishment, subject to compliance of “know your client” requirement:

Provided that if any such instrument has already been issued, prior to 3rd February 2004, to a person other than a regulated entity, contract for such transaction shall expire on maturity of the instrument or within a period of five years from 3rd February, 2004, whichever is earlier.

This means by Feb 3, 2009, all P-Notes (which are “Offshore Derivative Instruments” or ODIs) made out to “unregulated” entities by FIIs or sub-accounts, must be closed. Individuals are definitely unregulated entities.

That’s a year from now. And who is impacted? Any US individual investor that holds a P-Note. Like those of Barclays’ iPath MSCI India Index ETN. ETFs should not qualify because they’re not ODIs (they’re actual holdings). ETNs have a slight tax advantage over and ETF in the US.

That means the iPath ETN, which has a due date[1] of 2036, is going to be out of options soon. It has about $1 billion in assets, so that should get unwound in the next 12 months. (Money may flow to ETFs though) I don’t know many other P-Note issuers (who issue to individuals) – do you?

They all have to get rid of a lot of issued notes. Chances are, they’re going to do it now on an index rebound. Watch your long positions.

[1] (ETNs are financial voodoo-magic. They’re disguised as debt when they work like equity, so they have a “due date” and all that).