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Introduction

India's growth, the second-fastest among the world's 20 major economies, has been luring foreign investors especially hedge funds. As per SEBI estimates, of the total foreign stake in Indian companies ,51.6% of the assets under custody is through PNs .The main reason for the sudden spurt in PNs is due to the regulation imposed by SEBI on who can register as an FII. As hedge funds cannot register as FII’s the only route of entry available to them is through PNs.
The appreciating rupee, the galloping stock market and the fear of their being a break in the stock market bubble was an immediate source of concern to both the RBI and the Finance Ministry .This led them to pressurizing the SEBI to come out with regulations on banning of PNs.

Background

Growth of the stock market

“ It took the index a little over 20 years to reach the first 10,000 mark but a just a little over 20 months to double that score” – Economic Times,29th Oct 2007.

This statement best brings out the core issue behind the participatory note saga.
The Indian stock market achieved unprecedented highs in the recent past. The Sensex crossed 20,000 for the first time in its history on 29 October 2007. It took the market only ten trading days to reach from 19000 to 20,000. Part of the euphoria surrounding the Indian stock market is due to expectations that the US Federal Reserve would cut its interest rates. This, along with the recent subprime crisis in USA, has weakened investor sentiments towards US stocks, and is likely to benefit India.

Historical growth of Participatory Notes in India

PNs are financial derivative instruments used by investors or hedge funds not registered with SEBI to invest in Indian securities .Foreign investors have been enticed by India ever since it began liberalizing its financial markets in 1990s. PNs represent an instrument that satisfies...