14.18       ndian    onom
            derivative instrument’, i.e., an ODI) is         (iv) PNs also offer an important hedging tool
            the restrictions on foreign investments.              to a foreign investor already registered
            For example, a foreign investor intending             as an FII. For example, an FII may wish
            to make portfolio investments in India                to obtain ‘long’ exposure to a particular
            was required to seek FII registration for             Indian security. The FII can hedge the
            which he is required to meet certain                  downside exposure to the listed security,
            eligibility criteria. Lack of full Capital            already purchased by purchasing a ‘cash
            Account Convertibility further enhances               settled put option’. Although the Indian
            the entry barriers from the perspective               exchanges offer options contract, these
            of a foreign investor. However, Since                 contracts have a maximum life period
            January 2012, the Indian government
                                                                  of three months, beyond which the
            has taken a decision to give direct access
                                                                  FII shall have to rollover its positions,
            to such prospective ‘foreign individual
                                                                  i.e., purchase a fresh option contract.
            investors’ who were hitherto banned to
            invest in equity of Indian companies.                 Alternatively, it can avail of a PN which
                                                                  can be customised to cater to its hedging
       (ii) The off-shore derivative market allows
                                                                  requirements.
            investors to gain exposure to the local
            shares without incurring the time and             (v) Potential investors who would like to
            costs involved in investing directly. In              take direct Indian exposure in future,
            return, the foreign investor pays the PN              may make initial investments through the
            issuer a certain basis point(s) of the value of       PN route so as to get a flavour of future
            PNs traded by him as costs. For instance,             anticipated returns.
            directly investing in the Indian securities      (vi) Further, trading in ODI/PNs gives an
            markets as an FII, has significant cost and           opportunity to offshore entities to have
            time implications for the foreign investor.           a commission based business model. This
            Apart from seeking FII registration,                  route provides ease to subscribers as it
            he is required to establish a domestic                bypasses the direct route which may be
            broker relationship, a custodian bank                 resource heavy for them.
            relationship, deal in foreign exchange
                                                            (vii) And lastly, it was a highly ‘safe and
            and bear exchange rate fluctuation risk,
            pay domestic taxes and/or filing tax                  lucrative    route’    to     invest   the
            return, obtain or maintain an investment              ‘unaccounted’, ‘even illegal’ money into
            identity, etc. These investors would rather           the Indian security market for huge profits
            look for derivatives alternatives to gain a           (during the booming period). Experts
            cost-effective exposure to the relevant               even imagined that it may be allowing
            market.                                               the ‘black money’ of India (stashed away
      (iii) Besides reducing transactions costs, PNs              from India through ‘hawala’ kind of
            also provide customised tools to manage               illegal channels and deposited in the tax
            risk, lower financing costs and enhance               havens of the world in ‘Swiss Bank’ kind
            portfolio yields. For instance, PNs can               of financial institutions) to get invested
            also be designed for longer maturities                back in the market. Again, ‘terrorist
            than are generally available for exchange-            organisations’ might have been using this
            traded derivative.                                    route, too.