Local P-Note hysteria is unfounded

WhetherVietnamshould quickly exercise tight control over an investment tool called participatory notes, or P-Notes, has generated heated debate. VietCapital Securities analysts tell VIR there is little to worry about.

There is an argument that if Vietnam does not quickly introduce tight management of P-Notes, in cases when foreign investors’ trading values rebound to the pre-crisis level and capital inflows via P-Notes surge, the country will face some unpleasant consequences. These include large market volatility, movements of capital that cannot be tracked down and a boom in money laundering.

In this article, we manage to present an objective analysis on this controversial financial instrument. Some investment banks like Citibank, Deutsche Bank and HSBC have issued P-Notes via which investors can hold Vietnamese securities without registering with market regulator, the State Securities Committee.

P-Notes is a financial derivative, usually offering investors portfolios of blue-chip stocks with good liquidity and transparency. Any dividends or capital gains collected from the underlying securities go back to the investors. In cases when P-Notes owners opt to divest their share holdings, issuers of P-Notes will return funds based on current trading prices of P-Notes. Issuers of P-Notes are paid fees to hold on to stocks for investors.

Currently, P-Notes statistics relating to Vietnamese securities are not available. But, we know share holdings via P-Notes are mostly limited to a small group of blue-chips, less than 30 stocks. To tout P-Notes, prestigious investment banks like Citibank and Deutsche Bank trumpet Vietnamese market prospects, a good marketing tool for the country.

While Vietnam’s economy and stock market are showing signs of a sustained recovery and investment prospects are becoming brighter, portfolio capital routed via P-Notes will quickly surge, enlarging market trading volumes.

However, as owners of P-Notes do not have to register with market regulators and are not subject to administrative procedures in opening an account and forex management, capital inflows via P-Notes can experience U-turns. Amid market downturns, investors can divest their holdings and hard on the heels, liquidation pressures on issuers of P-Notes will mount up. This might create market turbulence.

As P-Notes give investors easy market entry and exit points, they attract interest from many opportunity funds with short-term investment approaches. However, stock markets need both short and long-term capital. While long-term capital helps solidify market sustainability, short-term inflows help heighten liquidity, which is vital to market development.

In Vietnam, foreign investors make up a pretty small stake of total market trading value. Our statistics show the figure, so far this year, is only 9.6 per cent. In July 2009 alone, foreign investors’ trading began to soar, accounting for 14 per cent. Thus, capital via P-Notes, by our calculations, is in the range of 5-7 per cent, which cannot cause market turbulence.

On the other hand, foreign players are a positive market driving force. In Vietnam, along with increased foreign trading values, market sentiment picked up. We believe the growth of foreign portfolio capital is positive, rather than negative. Money laundering is the process of taking the proceeds of criminal activity and making them appear legal. In other words, laundering allows criminals to transform illegally obtained money into seemingly legitimate funds.

Capital routed via P-Notes is mobilised by leading global investment banks from institutional and individual investors who register with their home country regulators. Moreover, prestigious banks all apply a tight examine process against money laundering in line with home country rules. Funds from those banks, thus, are internationally recognised as “legal” or “clean”.

Meanwhile, money laundering activated via private funds and country funds is much easier. Thus, money laundering via P-Notes, if it is occurring, is not big and much smaller than that via country funds, usually with a simpler internal supervision process.

With the above arguments, we believe P-Notes have played a positive role in the Vietnamese stock market and are yet to show signs of danger. However, concerned authorities need to consider making information on P-Notes capital from intermediary institutions available. With rational management, we believe P-Notes are not a threat and can benefit the Vietnamese stock market.