Sebi says Doors to Open for Hedge Funds Soon

But North Block mandarins say govt will tread carefully, study global regulations first.

December 8, 2006

India may allow hedge funds to directly invest in the stock markets by the middle of next year.

The market opening could take place under the issuance of new rules to govern foreign portfolio investors, the Financial Times reported on Wednesday, quoting Securities and Exchange Board of India chief M Damodaran.

When contacted by DNAMoney, Damodaran said, "We didn't say we would open it to hedge funds. We said we will see each application in its own merit." He did not explain further.

Currently, hedge funds cannot directly trade in Indian stocks, though they can invest through participatory notes (PNs) or instruments linked to underlying shares traded by foreign institutional investors.

The new initiatives affecting hedge funds would be part of an overall review of regulations overseeing foreign institutional investors, which may lead to clearer guidelines about who should be allowed to participate in the country's stock market, the FT report said.

Finance ministry officials said the government is currently examining in detail emerging global regulatory frameworks governing these funds.

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"The government will tread cautiously because hedge funds worldwide are largely unregulated and lack transparency," a ministry official said.

A policy that allows hedge funds into stock markets would also face political resistance from the government's Left allies, which have been critical of what they see as inflows of speculative foreign capital into Indian capital market. The government's decision to await clarity on regulation of hedge funds globally follows the recommendations of the expert group headed by chief economic advisor in the finance ministry Ashok Lahiri.

The group was constituted at the behest of prime minister Manmohan Singh to consider how foreign institutional investor (FII) inflows can be encouraged and whether existing regulatory framework adequately covers the aspect of reducing the vulnerability of capital markets to the flow of speculative capital. The group comprising representatives from the Reserve Bank of India, Sebi and the Department of Economic Affairs had recommended that the policy on hedge funds should be put on the hold till the regulatory developments in the US and elsewhere on hedge funds are available. Finance ministry officials said the government has decided that the worldwide experience, including in the US, needs to be studied before a policy is finalised.

While not referring to the Financial Times report, finance ministry officials said the timing and safeguards for allowing hedge funds investments into the stock markets will be a policy decision to be taken by the government in consultation with the RBI and as such it does not fall in the independent domain of the market regulator Sebi.

The National Common Minimum Progamme of the UPA government states that FIIs will continue to be encouraged, while the vulnerability of the financial system to the flow of speculative capital will be reduced. On the RBI side, scepticism runs deep, beginning at the very top. "Hedge funds are opaque. Information about their portfolio is infrequent and there is a need to maintain a data base of hedge funds' position," governor Y V Reddy had said in September, during a Ficci-IBA banking conference, adding that transparency is important for the sake of investors.