Market regulator Sebi on Thursday announced new rules for foreign investments through financial instruments such as participatory notes, asking FIIs to wind up P-Notes for investing in derivatives within 18 months.

Sebi chairman M Damodaram announced the decision after a meeting of the Board, which also approved imposing curbs on P-Notes for investing in spot market. The new norms would come into effect from Friday.

In derivatives, foreign institutional investors (FIIs) and their sub-accounts cannot issue fresh P-Notes and will have to wind up their current position in 18 months, he said.

In spot market, FIIs will not be allowed to issue P-Notes more than 40 per cent of their assets under custody. The reference date for calculating such assets will be September 30, Sebi said. The provision will come into effect from close of trading hours on Thursday.

Those FIIs who have issued P-Notes of more than 40 per cent of their assets, could issue such instruments only if they cancel, redeem, or close their existing PNs. Those FIIs who have issued P-Notes less than 40 per cent of their assets under custody can issue additional instruments at the rate of five per cent of their assets. 

FIIs will have to be registered on a permanent basis instead of earlier practice of renewing registration every three years, Sebi said.

Pension funds, foundations, endowments, university funds, charitable societies, which may not strictly fit into the category currently, can now register as FIIs.

Asked for a mechanism to check terror funding in stock markets coming in the shape of corporate entities, Damodaran said as of now there was no such evidence. "Anyway, security market regulation is not an answer for everything. There are other agencies to look into this," he said.

Damodaran also said the date of September 30 was fixed as the reference for calculating assets under custody of FIIs since this was the latest date for which data is available.

Sebi stuck to its original proposal of October 16 that sent stock market into a tailspin the following day. The Bombay Stock Exchange baromoter Sensex lost 1,700 points within minutes of opening on October 17, but later recovered after Finance Minister P Chidambaram assured that the steps were not aimed at curbing capital inflows.

The Sensex has been volatile but has since then recovered most of the losses. It closed 258 points up on Thursday at 18,770.89 points. Sebi had also interacted with FIIs and brokers before finalising the regulations.

Damodaran had earlier asked sub-accounts of FIIs that issue P-Notes to register as FIIs for investing in the Indian capital market. This was to make sure that all foreign funds come to the country through the front door. Following Sebi's directions, as many as 20 such agents have offered to register as FIIs.

P-Notes are instruments like contract notes issued by FIIs to overseas investors who cannot directly invest in equity market as they are not registered. Out of over 1,100 FIIs registered with Sebi, only 34 have been issuing PNs.