Participatory notes (PNs) can be issued only to regulated entities, according to a clarification issued by the Securities and Exchange Board of India.

This should set to rest market fears that all PNs will be banned. The finance ministry has already accepted Sebi's recommendation that the ban will be applicable only to unregulated entities-- that is, entities domiciled in places without recognised regulatory bodies.

The cutoff date for the ban on unregulated entities is February 3, 2004, after which no business can be transacted with them.

• Sensex soars by 223 points
• Is the feel good factor deserting the bourses?

Moreover, PNs that have already been issued to unregulated entities will have to be wound down or allowed to expire on maturity.

In any case, they cannot be permitted to remain in force beyond five years. According to Sebi data, outstanding PNs are roughly in the region of Rs 20,000 crore (Rs 200 billion).

Explaining its decision, Sebi said by way of clarification that there was no change in the "policy of FII (foreign institutional investor) investments in India except by way of strengthening the 'know your client' regime."

A Sebi release says that "with effect from  February 3, 2004, overseas derivative instruments such as participatory notes (PNs) against underlying Indian securities can be issued only to regulated entities and further transfers, if any, of these instruments can also be to other regulated entities only".

FIIs and their sub-accounts will be required to ensure that no further downstream issuance of such derivative instruments is made.

An analysis of PNs by Sebi has shown that there were several layers of investors to whom PNs were issued and details beyond the first level were not forthcoming.

Often the entities turned out to be overseas corporate bodies (OCBs), which are banned from transacting in the equity markets in India.

Sebi also said it would "be in a position to ascertain, if circumstances so warrant, details of the ultimate investors investing through PNs and other such instruments in the Indian market".

FIIs that transact on behalf of such clients have been told to exercise due diligence and maintain complete details of the investors, "based strictly on 'know your client' principles."

To facilitate the process of transition, derivative instruments already issued  and outstanding against unregulated entities will not be required to be terminated immediately, Sebi said.

"It has been decided that the said contracts will be permitted to expire or to be wound down  on maturity, or within a period of five years, whichever is earlier." A circular is expected to be issued soon.