Global Yields Near Zero Pique Demand for India Structured Notes

Edelweiss Financial Services Ltd., a Mumbai-based brokerage and investment banking firm, is seeing increased interest from global institutions for onshore structured notes in India as interest rates in Europe, Japan and the U.S. hold near zero.

Overseas investors can currently only purchase structured notes in Asia’s third-largest economy if they are registered as foreign portfolio investors or foreign institutional investors. Some rupee-denominated onshore structured products can offer returns as much as 6 percentage points higher than offshore offerings, according to investment advisory Karvy Capital Ltd.

The economic reforms laid out by Prime Minister Narendra Modi and expectations the central bank will cut rates are making Indian bonds one of the region’s most attractive investments, according to JPMorgan Chase & Co. Gross domestic product will expand 7.4 percent in the year through March 31, the Statistics Ministry estimated last week, on par with expansion in China.

“India is attracting quite significant inflows of funds,” Ben Sy, the head of fixed income, currencies and commodities for Asia at JPMorgan’s private banking unit, said. “When rates are cut, the rise in bond prices will more than offset weaker foreign exchange concerns.”

All that means structured notes -- debt instruments combined with derivatives that allow investors to benefit from moves in equities or rates while offering them some capital protection -- are piquing the interest of buyers, according to Vivek Sharma, Edelweiss’s head of investment advisory and alternate solutions group.

30 Percent Coupon

Edelweiss began offering onshore structured notes through funds to foreign investors in 2012 but it was only recently that interest began to pick up, according to Sharma.

“The interest used to be from domestic institutions with an offshore presence, but of late, we’ve started to see interest from global institutions,” he said in a Feb. 18 interview. “We’ve concluded a couple of trades and are in discussions for a few more in coming months.”

The notes, issued by Edelweiss, are sold via funds based in Mauritius that use their corporate debt quota through the foreign portfolio or institutional investor program to buy the securities. Companies in India often route investments into the country via firms based in Mauritius because the capital gains those firms make on Indian shares aren’t taxed onshore.

One 42-month note sold by Edelweiss in January pays the higher of a 30 percent coupon, or the gain in India’s CNX Nifty Index at maturity. The CNX Nifty, up 7.4 percent year-to-date as of Feb. 19, is the main index for large companies on the National Stock Exchange of India. It rose 31.4 percent last year.

“If you consider a simple fixed-coupon structured note, the yield difference can be about 200 to 300 basis points,” Hardik Shah, an associate vice president of structuring at Karvy Capital in Mumbai, said. “For auto-callable notes, the difference may be up to 600 basis points.”

Interest rates in India are among the highest in Asia. Bank of India Governor Raghuram Rajan last month cut the repurchase rate by 25 basis points to 7.75 percent as consumer inflation eased. He had raised it three times since taking office in September 2013. The rate is expected to drop to 7.25 percent by the third quarter, according to the median forecast of analysts in a Bloomberg survey.

Without the tax benefit Mauritius offers, investors may be no better off than had they invested in offshore securities, according to JPMorgan’s Sy.

“The treaty between India and Mauritius isn’t permanent and can change anytime,” he said. “If you can’t get the tax benefit, it wouldn’t be attractive to go into the local market.”

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