According to estimates by Citigroup India, P-note investments, excluding the underlying shares, account for 34 per cent of FII assets with custodians in BSE-500 companies.

Sebi stipulates that P-Notes can account for up to 40 per cent of FII assets under custody. This leaves room for FIIs to increase their exposure through P-notes 6 percentage points.

The Citigroup note said that as in August 2007, total FII holdings in India stood at $204 billion excluding American Depository Receipts (ADRs) and Global Depository Receipts (GDRs).

ADRs and GDRs are negotiable certificates that represent a given number of a company's shares and are listed and traded independently from the underlying shares.

"Excluding ADRs/GDRs, that number would have been around $172 billion," the note said.

Calculated on the August-end data provided by Sebi, FIIs' total P-note exposure is $59 billion. If this is 34 per cent of the total P-note value, excluding derivatives, FIIs can invest $10.4 billion more.

In its draft proposal on restricting use of P-notes, Sebi has proposed an incremental rate of 5 per cent for issue of P-Notes for FIIs with less than 40 per cent of their assets in P-notes.

The real concern, according to Citi, is that lack of new P-Note issues with underlying derivatives will take away hedging options for exposure in the cash market.

This could be a deterrent for new hedge fund inflows since investors hedge their positions in derivatives. Sebi has proposed to disallow issuing P-notes for derivatives contracts.

Another issue is that there is no data available on sub-account exposure in P-notes with derivatives as underlying.

Analysts handling FII business with domestic brokerage houses say the data given by Sebi in its draft proposals is up to August and the real increase in P-notes after that period is not known.

According to an FII representative, if FIIs increase direct investment, the percentage of P-notes to total investment will drop further, giving them headroom to issue fresh P-notes.