Vol 2 (2005) - Issue 6

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Hedge Funds - The Indian Regulatory Regime

Introduction

As India races ahead to be one of the prime markets for global investment in the Asia Pacific region, the much discussed financial entity of hedge funds needs a closer look. This article attempts at understanding the concept of hedge funds in the realm of Indian securities market, the regulatory regime of foreign hedge funds in India and the trend in the future.

Hedge Fund: The concept

There is no universal meaning of hedge fund. Hedge funds can broadly be stated to be unregistered private investment partnerships, funds or pools that may invest and trade in many different markets, strategies and instruments.
Certain common characteristics of hedge funds can be identified. Usually, hedge funds:

(a) are organized as private investment partnerships or offshore investment corporations;

(b) use a wide variety of trading strategies involving position taking in a range of markets;

(c) employ an assortment of trading techniques and instruments, often including short selling, derivatives and leverage;

(d) pay performance fees to their managers; and

(e) have an investor base comprising wealthy individuals and institutions and a relatively high minimum investment limit.

Understanding the Indian securities market

Over the last 125 years, the Indian securities market has evolved continuously to become one of the most dynamic, modern and efficient securities markets in Asia. Today, Indian markets conform to international standards both in terms of structure and in terms of operating efficiency. India has two national exchanges, the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). Each has fully electronic trading platforms with more than 9400 participating broking outfits.
There are more than 9600 companies listed on the respective exchanges with a combined market capitalization near USD 125.5 billion.
The securities market has two interdependent and inseparable segments, the new issues (primary market) and the stock (secondary) market. The primary market provides the channel for sale of new securities while the secondary market deals in securities previously issued. The price signals, which subsume all information about the issuer and his business including associated risk, generated in the secondary market, help the primary market in allocation of funds. The issuers of securities issue (create and sell) new securities in the primary market to raise funds for investment and/or to discharge some obligation. They do so either through public issues or private placement. There are two major types of issuers who issue securities. The corporate entities issue mainly debt and equity instruments (shares, debentures, etc.), while the governments (central and state governments) issue debt securities (dated securities, treasury bills). The secondary market enables participants who hold securities to adjust their holdings in response to changes in their assessment of risk and return. They also sell securities for cash to meet their liquidity needs.
A variant of secondary market is the forward market, where securities are traded for future delivery and payment. Pure forward is outside the formal market. The versions of forward in formal market are futures and options. In the futures market, standardized securities are traded for future delivery and settlement. These futures can be on a basket of securities like an index or an individual security. In case of options, securities are traded for conditional future delivery.