SEBI lifts embargo on hedge funds

Date: Wednesday, October 10, 2007
Author: George Smith Alexander, The Economic Times

 MUMBAI: Capital market regulator Sebi has finally lifted the embargo on hedge funds, albeit in a calibrated way. In the past fortnight, close to six hedge funds have been allowed to register with the regulator.

However, these funds, which have been permitted to come in directly, must fulfil two key criteria—they must be registered with/regulated by the financial market regulator in their home country; and they must have at least a one-year track record. The funds will have to fulfil all the conditions that apply to foreign institutional investors. These funds have been registered as sub-accounts or FIIs.

They will have to follow similar documentation norms applicable to other overseas investors, which means submission of constitution documents and financial statements, among other things.

The hedge funds that have registered are said to be a mix of old and new funds. Bankers now expect them to invest directly in Indian stocks rather than through the more expensive participatory notes —a derivative instrument. Incidentally, in the recent rally, bankers said around 50% of the money has come in through P-notes.

While older funds like pension and insurance funds have been steady investors into the market, hedge funds have also raised their exposure,” said a senior banker.

While locations of these funds are available only with the P-note issuers and subsequently with the regulator, bankers said funds and institutions from markets like Austria, the Netherlands, Germany and some Scandinavian countries have shown interest. Also, inflows from markets like the US, Middle East and Korea have gone up.

In India, financial market regulators like RBI have voiced their discomfort over allowing hedge funds to register like other FIIs. Other than the little disclosure and the high risk and complex trading strategies of these funds, regulators fear they could lend greater volatility to the market, and thereby hurt retail investors.

Hedge funds, which are bullish on India, have preferred to enter the market through FII sub-accounts and purchase of P-notes by foreign security houses. Sub-accounts include foreign corporates, funds or portfolios established outside India, on whose behalf investments are made in India by a FII; and the investment decision or the actual fund management is done by the FII.

Many unregistered foreign investors, including hedge funds, would rather prefer something called a third party sub- account.