Indian hedge fund investment issues

The big news in Asian investing over the last two weeks has been the decision by Indian authorities to halt investment in P-notes by hedge funds via their investment banks. The issue has a number of complexities but at its heart is the ability of the prime brokers to offer access to the Indian market to hedge funds.

The steps taken by the Indian Government have been justified by them saying that the large capital inflows this year were causing Indian exporters problems, that they needed to know who was investing in their stocks, that they want funds to come in via the front door not using P-notes.

Unfortunately this looks like the protectionist India of old. India has a an exciting future ahead as a huge country with a growing and educated middle class and a legal system that while far from perfect is actually considerably easier to understand and deal with than the Chinese system for most US and European firms.

All of the public statements thus far have tried to calm foreign investor nerves - and the announcements last night were important due to the way they seemed to put a final position on a number of issues - but actually SEBI has done little thus far to open the door to the fastest growing segment of the global asset pie, hedge funds.

Large foreign inflows will greatly benefit the Indian economy. Indian executives will be required to run and staff local operations. Firms will need premises, IT and all of the other basics needed to support a sophisticated investor. They say that for every job on Wall St two others are created to support it in Manhattan. I would suggest the ratio will be much larger in India.

The losers of course, if SEBI, the RBI and the politicians do truly open up their markets are going to be the entrenched owners of business enterprises be they old families that refuse to reform or government enterprises that are in need of new investment and technologies.

Right now the investing community loves India. It is up to the Indian government and its regulatory bodies to recognise and cultivate the relationship. Open the door to all types of foreign investment in listed firms.

August newsletter comments

As our newsletter goes to print regional markets are calming down but the news relating to problems inside a variety of financial intermediaries continues. The good news has got to be that Asia remains a place where high returns can still be generated and we continue to see strong interest from established funds and institutional investors looking to increase their presence in the region.

In Hong Kong there continue to be positive moves at easing the entry of new participants into the Hong Kong financial industry while maintaining established standards. We are experiencing speedier processing time and a focus on more material issues than has been the case. This is to be welcomed and hopefully is part of the process of tidying up the entire licensing regime particularly the forms and the exams.

The forms are not well drafted and can cause some of the larger institutions considerable difficulty in answering fully. The Hong Kong Securities Institute, not part of the SFC, sets and administers the exams. There has been much criticism of the exams in the past and while they are marginally better than they were they are still an unnecessary hindrance to the entry into the market of otherwise experienced personnel.

We are of the view that there is a role for ensuring basic market knowledge of incoming market participants, a role for a competent educational body training and developing local talent, and a role for an industry body offering high level ongoing training. However the HKSI seems to be focussed on developing its educational status rather than ensuring that persons who want to come to Hong Kong can do so quickly and appropriately to the benefit of the economy as a whole. The pass rate for some of the exams remains too low, the questions appear to be poorly structured and the nature of the subject matter that will be examined remains opaque.

We believe that the HKSI needs to separate out its role as a filter for market entry from its role as an educational body. The two roles are currently conflicting.

While on the subject of training in Hong Kong, licensed firms should remember that the obligation to attend continuous professional training accumulates on a calendar year basis and all licensed personnel and their companies need to ensure that hours are completed by year end. Our clients can access our online calendar of all upcoming training to assist with planning attendance.

In Singapore there has been a number of long outstanding Capital Markets Services Licence applications which have now been processed; however there remain issues with the requirements that the MAS is imposing as part of the process of issuing licences. In some instances, MAS is requesting additional reporting to MAS from firms beyond what is required in the regulations; in others it is requiring the appointment of dedicated compliance officers. In the latter case the industry generally feels that for small operations, this is an unrealistic requirement (particularly when MAS is critical of individual employees wearing dual hats) and that it would be easier if MAS took the approach of allowing them to nominate a business person to be responsible for compliance rather than requiring an additional person to be hired who is an expensive and under-utilised resource. Our fear is that this requirement is leading to firms hiring inexperienced and inappropriate persons to execute the compliance function which surely not the result MAS desires.

Concurrent with the revised fit and proper criteria published recently by the MAS, we are aware that firms who are exempt fund managers are now being inspected by the MAS. While these firms are exempt from the licensing regime they are not exempt from Singapore law (such as market manipulation, insider dealing, anti money laundering) nor from the requirement to have proper internal controls in place and to meet statutory filing requirements. These inspections and the resulting comment sheets serve as timely reminders of this.

In India there were recent positive comments from SEBI about the entry of hedge funds into Indian capital markets. Readers may recall that we have been sceptical about how quickly hedge funds will be able to register in their own right. The recent announcements are positive and may be an indication that Indian regulators are realising the enormous potential advantages of capital markets liberalisation in such a large and growing economy.