With global hedge funds, an industry estimated at over $1.5 trillion and shrouded in secrecy, worrying stock market regulators even in liberal market economies, it was perhaps only to be expected that Sebi would clamp down on their playing the Indian capital market through that shadowy instrument known as the participatory note (PN), used as an indirect way to bet on the value of equities traded here. And indeed, the regulator has finally acted, giving PN players 18 months to wind down derivative operations, blocking such FII sub-accounts, and offering, in lieu, an easier path for direct trading by overseas entities. Broadly, the message is clear: funds that go unregulated elsewhere?as do hedge funds, since their investors are wealthy well-informed people who know their risks and do not plead for state intervention?should lay off the Indian market. Serious players, including individuals, should come forth and register themselves.
What has prompted this? The proximate ?big picture? reason may have to do with worries about the country being swamped with dollar inflows, which have rattled India?s monetary policy framework, and hedge funds are awash with cash (the kind of cash that usually attracts ?hot money? suspicions, too). Going by Sebi?s statements, the reasoning has been led by a quest for transparency in the context of ?know your customer? norms; the final beneficiaries of PN investments are mostly unknown, and it has not helped their claims to being a benign presence that hedge funds were seen at the forefront of the US credit derivatives market based on subprime lending. Given all this, Sebi?s efforts to discipline PNs could serve to contain the maze of risks and perplexities that the capital market finds itself exposed to under the current state of globalisation. Also, Sebi?s move could beget better tax compliance, and encourage institutional players to operate fully within Indian borders?a minimal condition for Mumbai to become an international financial centre. Regulatory alertness, in itself, could serve this cause as well. Yet, it is worth bearing in mind that derivatives have evolved to such complex levels that there is no way to stop anyone betting on the value of any variable in the public domain, and anonymous activity that respects no borders is virtually impossible to monitor in the information age.
