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Foreign funds for ‘registered-FII’ status

Indian policymakers will consider the merits of allowing hedge funds to register formally with the securities market regulator, the Securities and Exchange Board of India, and investing in the local markets at a meeting this week.
The proposal to allow hedge funds — which are pooled investment of a few wealthy individuals and families — has been in the works for quite a while. The government has been of the view that it makes better sense to allow formal entry for these funds by registering them as foreign institutional investors (FIIs) in order to discourage the practice of such funds investing in the Indian equities indirectly through participatory notes (PNs).

A combination of rigorous norms relating to registration of foreign portfolio investors and higher cost of transactions have prompted hedge funds to take an exposure to Indian stocks through a derivative instrument — participatory notes. This instrument, popularly known as PNs, has as its underlying — Indian stocks and the holder — entitled to capital appreciation and other benefits. Industry estimates place the share of hedge funds in total foreign portfolio flows close to 40%. In 2006, portfolio inflows aggregated $8 billion. In 2007, portfolio flows have been robust, especially in the past few months.

Officials associated with the proposal said that existing laws do not bar the registration or entry of hedge funds. But for long, given the suspicion with which hedge funds are viewed for their role in destabilising markets and for other practices, Indian regulators have been reluctant to allow formal entry. “Even now they are permitted, but then we need to discuss it and take a decision which is more clarificatory in nature,“ a senior official said.

The plan centres around allowing hedge funds — wherein now pension funds, university and endowment funds also invest to register with the regulators in India — once they fulfil stiff know you customer (KYC) norms. The proposal is set to be discussed at a meeting of capital markets regulator this week. The Reserve Bank of India has in the past expressed concerns relating to hedge funds and their perceived role in rocking the financial stability boat and the origin of these funds. Globally, many other central banks are also not comfortable with not just the hedge funds, but also private equity funds.

The other factor which has to be taken into account is the potential impact of allowing these funds. The surge in capital flows has already put a strain on monetary policy management in terms of dollar mop-up and then sucking out the rupees released through issue of bonds to prevent a growth in the money supply. This comes at a cost to the exchequer in terms of interest paid on the bonds issued to suck out the liquidity generated due to short-term capital flows.

In the US, where hedge fund assets hold trillions of dollars of investors’ assets, the Securities and Exchange Commission (SEC) last week voted to adopt a new anti-fraud rule under the Investment Advisers Act to rein in investment advisers of hedge funds also after a spate of charges against them. The SEC has voiced concerns in the past about the role of hedge funds that invest in equities, fixed income securities, currencies and take speculative positions. But it has also acknowledged the contribution of hedge funds to boosting market efficiency, liquidity and in allocating financial risks.

Source : Times of India

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