The Reserve Bank of India on Wednesday sent out letters to a section of foreign brokerages seeking details of their turnover in the participatory notes business, as also the underlying scrips on which these notes are issued.

The RBI is reportedly looking to check the origins of these funds. The move follows its concerns over possible misuse of participatory notes by hedge funds and other entities that are not allowed under the current regulations.

Participatory notes are like contract notes issued by registered FIIs to their clients outside India.

These are issued to investors who do not want to go through the various regulatory processes in India which require them to make at least a minimum level of disclosure.

According to broking sources, participatory notes enable foreign hedge funds to invest in India through broking firms.

Now with the yields moving up in the United States, they have started liquidating these investments at a time when the Indian market has started looking up. This sends negative signals to the market and affects the overall business sentiment.

It may be recalled that the Securities and Exchange Board of India had first raised the issue of participatory notes through a circular in October 2001.

The circular said some FIIs were issuing derivatives/financial instruments against underlying Indian securities.

The circular had said these instruments were known by various names such as participatory notes, equity-linked notes, capped return notes and participating return notes.

With a view to monitoring the investment by FIIs through participatory notes, Sebi had decided that FIIs must report details of these instruments along with the names of the holders of these instruments.

In order to increase transparency, Sebi had in October 2001 issued a circular to all FIIs and their custodians advising them to report to the regulator as and when any derivative instrument with Indian underlying securities were issued/renewed/redeemed by them either on their own account or on behalf of sub-accounts registered with them.

Accordingly, FIIs are sending reports from time to time whenever they are issuing PNs. The disclosures in the reports submitted by FIIs are to be enhanced.