The Securities and Exchange Board of India has started investigations into what it thinks is an attempt by foreign institutional investors to circumvent the $1.5 billion limit on FII investments in the debt markets.

Preliminary information available with the stock markets regulator suggests that some FIIs are taking the equity investment route to fund their debt market exposure.

Sources said that, since there is no underlying documentary evidence, overseas money, reported to the regulators as intended for the equity markets, finds its way into the debt markets.

Though no firm details are available, sources said the modus operandi mimics the participatory notes process, which is common in the equity markets.

A foreign investor intending to play in the Indian debt market places his money with an overseas FII and enters into a token contract.

This FII then leases out a sub-account of a registered equity fund in India. Each fund could have several sub accounts like equity, debt or mixed (hybrid) accounts, etc.

Therefore, even though the Indian fund has exhausted its exposure limit to the debt market, it gets to participate more in the debt fund through the investment put in by the FII in its registered equity fund.

Sebi has a dual-track automatic route for overseas investments in the domestic debt markets, say sources. For one, there is a 100 per cent debt route, which is for investors interested in the debt side alone.

Foreign corporates and individuals are not eligible to invest through the 100 per cent debt route and can only approach the debt market through mutual funds or FIIs.

The other route is available to all FIIs. The guidelines state that out of the total amount put in equity funds, not more than 30 per cent can be invested in debt instruments.

Debt market instruments available for investments to FIIs include non-convertible debentures, partly convertible debentures, bonds, dated government securities, treasury bills, etc.