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Hedge funds’ conditional entry may benefit emerging markets

International Organisation of Securities Commissions (IOSCO) 32nd annual conference concluded with lot of discussions and deliberations over regulations and transparency regarding financial markets transactions and the need for closer cooperation among various regulatory bodies. The conference assumes more importance for a country like India, which is bracing itself for a gradual implementation of fuller capital account convertibility in a phased manner. In the backdrop of the Securities and Exchange Board of India (Sebi) considering the proposal to allow direct entry of hedge funds in the Indian market with conditions, this conference is important .

This is one area which is being closely watched by big players, both domestically and globally. There have been heated discussions and debates over this issue as hedge funds are often blamed for creating high volatility, which often tends to destabilise the market. Interestingly, Sebi has recently invited hedge funds to get themselves registered with it and enter the Indian market directly instead of coming through participatory notes (PN) issued by foreign institutional investors (FIIs) abroad.

Market experts say that hedge funds are very much active in India and are an integral part of the domestic equity market now. Even the restriction on investment of hedge funds prevailing in India has not deterred them from investing here. The more serious ones are entering through the offshore instruments issued by FIIs abroad. Interestingly, investment through the PN route and other instruments constitute 30% of the total FII investment in India. Nearly 1,000 FIIs registered with Sebi maintain more than 3,000 sub-accounts with it.

Sebi’s move comes at a time when the institutional fundamentalism have reached its peak where institutions are calling the shots and can singlehandedly decide the movement of the market. This is corroborated by the recent developments that has taken place in various stock markets, whereby a single macro-economic policy announcement from a country has resulted in institutions withdrawing funds and triggering a major sell-off across the globe. It is in this context that finance minister P Chidambaram, while addressing the IOSCO conference, said, “Inflows and outflows of capital will continue to pose difficult problems. We have to live with some degree of volatility in the equity, forex and debt markets, irrespective of the level of capital account convertibility. Some of the challenges originate from abroad on which we have little control.”

One school of thought feels that allowing hedge funds will definitely provide the much needed liquidity in the market and widen the scope of capital markets by bringing sophisticated investment products that use complex mathematical models in their investment strategies.

Ramdeo Agarwal, MD, Motilal Oswal Securities, said, “With the rapidly globalising and digitisation in economy and stricter (Know Your Customer) KYC norms, differentiating the different colours of money doesn’t make any sense. And Sebi’s recent move to allow hedge funds a direct entry is a move in the right direction. We are in dire need of money and allowing hedge funds will definitely infuse liquidity in the market. If hedge funds are allowed and after six months if we take a look at the markets it will be at an entirely different level.”

But memories are still fresh in everyone’s mind regarding the severe damages inflicted upon some of the sound financial economies by the hot money through portfolio investment among other factors leading to the South East Asian economic crisis of 1997. India was largely unaffected by those developments as the financial market was protected to a great extent. Now that the Indian economy has opened up to a great extent, inviting larger amount of portfolio investment into the country every year, Sebi will now be required to play a larger regulatory role and oversee the investment once hedge funds start investing. “It is the role of regulators to identify grey areas, if any, and they will definitely do that,” adds Agarwal.

Sebi has already initiated steps with a broader objective in mind to bring greater transparency in various deals and transaction executed in the market. The recent signing of memorandum of understanding (MoUs) by Sebi with other regulators will definitely enable closer cooperation between securities market regulators by providing its members the means to facilitate investigation and prosecution of cross-border securities violations as well as to enhance the enforcement of securities laws and regulation. Analysts feel that if hedge funds are allowed to operate in the Indian equity market with certain conditions which can hold them back in the domestic market for a longer period, they can definitely widen the market base.

Also, India will be in a much better position to utilise the foreign capital of these funds and this will be a very positive sign for the market. This will result in increasing the liquidity and depth in both derivative and cash market.

Source : Financial Express

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