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US hedge funds shut out

Date: Friday, October 26, 2007
Author: N Sundaresha Subramanian, Sanat Vallikappen, Sify.com

Mumbai: The doors may have shut for US-based hedge funds wanting to invest in India. That’s because, SEBI chairman M Damodaran said on Thursday that only entities regulated in their own countries will be allowed to participate in the Indian markets through the participatory note route.

US-based hedge funds are not regulated in their own country, while the UK’s Financial Services Authority monitors hedge funds in that country.

Stuart Smythe, executive director and head of equity, India, Macquarie Securities, said there were some grey areas in the new regulations cleared by the SEBI board.

The first of these pertain to assets under custody or AUC.

SEBI has said that those entities whose P-note exposure (with underlying as equity) is 40 per cent or more of their total AUC as on September 30, 2007, need to cap it at that level.

Meaning, any entity wanting to invest, say, Rs 100 crore, will have to reduce its existing position by an equivalent amount.

Smythe’s doubt: does the AUC move up as the market moves up? “Will there be a rest mechanism or the like?”

SEBI has clearly stated that only entities that are regulated will be allowed to register as a foreign institutional investor with it, and be issued with further P-notes out of the market’s AUC quota.

Smythe said more clarity as to the meaningful determination of regulated, and which bodies SEBI deems worthy, would be useful for all participants.

He also thinks raising money from international participants through IPOs and secondaries (such as rights issues) will be much harder going forward.

Damodaran said that the effective date for calculation of the AUC for the proposals on P-Note shall be September 30, 2007. The proposal will, however, take effect after close of trading hours on October 25, 2007.

In 2004, SEBI had amended its regulations to permit participatory notes, subject to the requirement that P-Notes ought to be issued only to “regulated entities”.

While this began as a measure that would have given access only to entities that are regulated by a special regulator, the SEBI clarified that any company registered with a registrar of companies in any jurisdiction would be regarded as “regulated entity”.

In short, the term “regulated entity” amounted to being a “registered entity”, which then practically excluded only individuals from access to P-Notes.

On Thursday, Damodaran added that “The 2004 regulations also say that such instruments as have been issued to unregulated entities should be wound up within a period of five years. The five years are not yet over, there are about 16 months and a few days left by my calculation. I think people who need those regulations and are in the marketplace should use that period to comply strictly with the regulations.”

But the ‘masters of the universe’, as the hedge funds are known, have got some encouragement, too.

The SEBI has modified the definition of what constitutes a “broadbased” fund.

It said the “broadbased” criteria shall now be modified to include entities having at least 20 investors, with no single investor holding more than 49 per cent (instead of 10 per cent at present).

Further to facilitate funds investments by new funds, it will apply the one-year track record rule only for the fund manager, and not the fund.

“The fund manager will have to provide the disciplinary track record details,” SEBI said.