Photographer: Dhiraj Singh/Bloomberg

Foreign Banks to Seek Relief From India's Derivatives Rule

  • Global firms warn of stock market volatility if rule applied
  • SEBI banned most indirect offshore holdings on Friday

Overseas banks met with India’s markets regulator to ask for relief from a new rule that requires investors to liquidate some of their offshore derivatives contracts, people with knowledge of the matter said.

The Securities and Exchange Board of India issued a circular on Friday that said the derivatives must be liquidated by the end of 2020 or by the instrument’s date of maturity, whichever is earliest. Banks, representing their clients, met with SEBI officials on Monday to ask for a three-month extension to roll over their July positions. The contracts usually have monthly maturity, meaning existing products will have to be rolled over by the end of this month or be liquidated upon expiration. Liquidating all the contracts at once will create huge volatility in stocks, the banks said, according to the people.

At issue are contracts known as participatory notes, which foreign banks create for offshore investors looking to trade in India’s $2 trillion equity market without registering onshore with SEBI. The regulator has been taking steps to cut down on the use of so-called p-notes, culminating in Friday’s announcement. The banks told SEBI officials on Monday that the rule would effectively kill the p-note market, said the people, who asked not to be identified because they weren’t authorized to speak on the subject.

“It remains to be seen what the full effects of this recent change will be on foreign funds, and if some funds choose to set up their own foreign portfolio investment accounts to trade directly, or exit the market altogether,” said Phillip Meyer, general counsel and chief operating officer of hedge fund firm Oasis Management (Hong Kong), which has traded Indian securities for more than 15 years.

SEBI will allow p-notes in single stocks for hedging cash positions of the same stocks, but it won’t allow hedging of index derivatives even if there is an underlying cash position, according to the people. A SEBI spokesman didn’t respond to an email and a phone call seeking comment.

The regulator said at the Monday meeting that it wants hedge funds to register as direct foreign investors and start trading derivatives onshore while they can still use p-notes to hedge their stock holdings, the people said.

The role of p-notes has diminished over the past decade as the regulator made it easier for foreigners to directly access the India’s market. P-notes accounted for just 6.3 percent of the 28.6 trillion rupees ($443.4 billion) held in equities, bonds and derivatives at the end of May, according to SEBI data, down from 56 percent at the end of June 2007. The notional value of p-note exposure to derivatives was 476.7 billion rupees in May, down from 557.8 billion rupees at start of the year, data from the regulator show.

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