Stock Exchange Watchdog SEBI has proposed that some urgent measures need to be taken to curb the use of some categories of derivates instruments by FIIs. SEBI may ban the use of Participatory notes which are issued using stock futures or options. Finance minister recently expressed his concerns regarding over-stretched Indian Stock Markets. Indian Stock markets are trading at all-time highs. The SEBI move to ban P-notes may have negative impact on Stock Markets.

As per SEBI records, 34 FIIs issue Participatory notes. In August 2007, the value of Participatory notes was nearly 51% of total assets under FIIs in India. As SEBI allowed P-Notes, the exposure of FIIs in P-Notes increased of 20% in March, 2004 to 51% during August, 2007.

The recent rise in was very sharp. The market has increased 1000 points to touch 19000 in just four trading sessions. The earlier bull-run till 18000 was completed in just 7 trading session. During these sharp gains in the stock markets, the FII inflows came mainly in form of P-Notes. Technical Analysts are concerned about the money invested in Indian Market could be for short term gains. And once FIIs pull out their funds from Markets, there could be sharp correction.

As per new SEBI proposal, FIIs and their sub-accounts will not be able to issue any fresh P-Notes in Indian derivatives. The P-notes cannot be renewed. The outstanding P-Notes on Indian derivatives will have to be squared up during the next 18 months.