A few months back, I had the opportunity to read V.
Umakanth's working paper on hedge fund regulation in India
(available on Mondaq and Hedge Fund Law Review). Umakanth, in his
paper sets out a framework for banking and capital market
regulators, the RBI and SEBI respectively, to regulate offshore
hedge funds using a variety of mechanisms- prohibition, disclosure,
registration and regulatory. My general comment on the article was
that the author is advocating regulation even before an industry
Fast forward to the current- Lehman's bankrupt, Goldman
Sachs and Morgan Stanley have converted into banks, a $700 Billion
bailout is in the offing, short selling is being banned
systematically from the US to Austria and US Secretary Paulson has
had to make unprecedented TV appearances to calm markets. Of
course, personal appearances are nothing new in India where the
finance minister regularly steps in to make statements for
"pacifying" markets, or the market regulator steps in
with "orders" to "stabilize" the market from
Despite the calming messages by the Indian banking and capital
market regulators to try and subvert the regular market mayhem that
has been a regular feature of the Bombay Stock Exchange (BSE) and
the National Stock Exchange (NSE), local investors are often at a
loss to understand:
why markets regularly see-saw by a couple of thousand points at
every influx or adverse stock movements by foreign institutional
investors (FIIs), or
why IPOs have all but disappeared and that the Indian markets
have been terrible performers in 2008, or
why the local mutual fund industry is largely fueled by cash
inflows from corporates rather than investments of the general
public, with the latter having a distinct preference of placing
cash in deposits with government owned banks.
Some reasons include:
the lack of financial innovation in Indian markets due to
severe restrictions in the form of complex taxation and a multitude
of regulators and legislation;
retail investors being denied access to alternative investment
products by a combination of high tax rates, a lack of modernity in
the decades old companies legislation (it still takes more than a
month to set up a company and years to wind it down), an
over-reliance on federal policies to determine the course of
corporate growth in states, and complex bureaucratic procedures on
the road to investing. On the other hand, foreign institutional
investors have access to Indian stock markets, which to these
investors, is an alternative investment class in itself;
Indian regulators allowing Qualified Institutional Buyers
(QIBs) to gain sequentially and substantially in primary market
offerings but does this category of a sophisticated investor need
regulatory encouragement in the first place?
These long-standing distortions have resulted in a scenario
where the most aggressive, legitimate, retail investors are limited
to investing in quasi-insurance or mutual fund schemes with (a)
plain vanilla equity or fixed income focus or (b) sectoral focus.
You got the math right- very few choices for a country of a
The regulators should concentrate on broad basing Indian capital
The 10 lakh rupee question is when offshore funds can invest in
the Indian markets, shouldn't the regulators make it conducive
for entrepreneurs to set-up domestic funds to tap domestic
investors completely? Tax-breaks or acknowledgement of pass-through
structures for tax purposes would certainly help the industry.
There is definitely a case in favor of creating alternative
investments to sophisticated investors in India. Advantages include
(a) investors opting for appropriate risk-reward scheme(s) that
suit their individual needs; (b) primary markets not necessarily
drying up each time the United States catches the flu; and, (c)
domestic hedge funds would force the growth of a healthy disclosure
culture (thanks to the much-maligned short sellers).
In fact the majority of the offshore funds investing in India
are guaranteed to have a very healthy mix of sophisticated resident
US and offshore investors. Sophisticated investors rarely like
being "commoditized" and it all boils down to a choice
between choosing a reputable fund manager to manage assets or to go
with the rest of the flock and invest with licensed fund
As you guessed, it is a problem of choice. In India, the choice
doesn't exist, yet.
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