Drop-halt-go drama on Dalal Street

At the end of the day, it still wasn’t clear whether Sebi’s efforts to curb inflows of anonymous foreign money into the country would succeed in doing that and if this would stop the unprecedented rise in Indian stock markets this year.

The Sensex ended Wednesday at 18,715.82 points, 1.8% down from its previous close.

See: Gainers and Losers

Much of Wednesday’s drama on the bourses was played out soon after trading began a little before 10.00am. Trading on BSE was halted for an hour after the Sensex plunged 1,500 points to hit the lower circuit breaker—a level that is set to prevent sharp rises or falls in the overall index and in the prices of individual stocks. Trading on the National Stock Exchange (NSE) was also halted for an hour after the broader Nifty index lost more than 500 points from Tuesday’s close of 5,668.05. The Nifty ended trading on Wednesday at 5,559.3 points, 1.9% down.

The fall was anticipated after Sebi released a report on Tuesday proposing new measures to curb inflows from foreign institutional investors (FIIs) through participatory notes (PNs), which account for a substantial portion of FII investments in the country.

FIIs that are not registered with Sebi can buy Indian equities through the PN route: a registered FII can buy the equities on behalf of the investor and issue it a PN.

Sebi’s move hasn’t gone down well with such investors, including around half a dozen hedge funds Mint spoke to which have invested in Indian equities through the PN route. Most of these fund managers did not wish to go on record with their reaction because of the sensitivity of the issue. Some claimed it was not easy to get registered as an FII in India, one reason why they have to take the PN route.

“Ideally, we (hedge funds) would like to get registered as an FII and then transfer our existing investments made through PNs to our own account," said the Singapore-based partner of a large hedge fund, which has more than $1 billion (Rs3,970 crore) invested in Indian equities through PNs. “However, this is easier said than done. We had applied for an FII registration three years ago. Our application is still pending."

Sebi neither has a clear policy for all categories of investors nor a clear definition for hedge funds, said the hedge fund partner on condition of anonymity. “Contrary to popular perception, hedge funds are not always short-term sellers. Many of them take long-term positions and they buy when the market dips."

A Hong Kong-based hedge fund manager of Indian origin said he hoped to get an FII licence to invest directly in India. “We are highly bullish on India. Whatever is the legal route available, we will use that to remain invested in India," added this fund manager, who has more than $400 million invested in India through PNs. “We have 18 months. It is likely that Sebi would extend that period if it does not liberalize FII registration norms. So there is no panic," he said.

Sebi has given FIIs that have taken a position in the derivatives?market?via PNs,?18?months to unwind these positions.

The list of hedge funds investing in Indian equities through PNs includes US-based Indus Capital Partners LLC, Sansar Capital Management and Singapore-based Tree Line Advisors (S) Pte Ltd.

Sebi’s Tuesday report said that its curbs on PNs were framed in consultation with the government and would be implemented urgently, after receiving comments from market participants within four days. Sebi’s board is meeting on 25 October to take a final decision on this issue.

“Most FIIs who currently issue participatory notes, have strong know-your-client (KYC) norms," said a Dubai-based hedge fund manager. “Therefore, the question of anonymity (it seems) is only for the Indian regulator. All the major FIIs have strict norms for registering a client," he added.

According to a Sebi study, five large FIIs—Morgan Stanley, CLSA, Merrill Lynch Capital Markets Espana, Citigroup Global Markets and Goldman Sachs—account for about 60% of PNs issued in India.

Alok Sama, founder and president of Baer Capital Partners Ltd, a Dubai-based investment firm, said the claim about the anonymity of money is baseless. “The registered FIIs in India are mostly banks and other credible organizations. The KYC requirements are very strong in the case of all these firms. There is very little chance for the so-called black money, gangster money or terrorist money to come through PNs," he added.

Popular and political perception differs. “The government does not know the source of nearly Rs3.53 lakh crore invested in the markets; this could be terror funds, drug money....," said Prakash Javadekar, a spokesperson for the Bharatiya Janta Party.

Sama’s firm has recently applied for an FII licence. It plans to invest about $500 million within six months of receiving the licence. “The FII registration process is straightforward, but certainly time consuming. India is a trillion-dollar-plus market. It should adopt easier norms for foreign investors."

On Tuesday, FIIs turned net sellers for the first time since the US Federal Reserve announced a cut in interest rate on 18 September. They sold shares worth Rs234.32 crore; domestic institutional investors were net sellers to the tune of Rs10.05 crore. On Wednesday, according to provisional data on BSE’s website, FIIs were net sellers to the tune of Rs2,012 crore while domestic mutual funds were net buyers to the tune of Rs285 crore.

FIIs have invested about $17 billion in equities since the beginning of 2007 and have been largely responsible in driving the Sensex to a peak of more than 19,000 earlier this week.

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