Sebi may relax registration of sub-accounts

The Securities and Exchange Board of India (Sebi) is considering a proposal to allow funds, which are not managed by foreign institutional investors (FIIs) to get themselves registered as FIIs' sub-accounts with the Indian regulator. The move will open the doors for several individual-run India-specific offshore funds.

Sources said Sebi will allow entry to such funds on a case-to-case basis, provided the FII concerned gives an undertaking that it will be responsible for all the activities of that sub-account. Also, these sub-accounts will also have to be a broad-based fund "� meaning it should have at least 20 investors, and no single investor should hold more than 49 per cent.

The Sebi move comes after the curbs on participatory notes (P-notes, or offshore derivative instruments that have Indian stocks as underlying) since October-end have virtually blocked all fresh investments by several India-specific long-only hedge funds and other overseas funds, which are managed by reputed fund managers.

Though no authentic data is available on the number of individual-managed India-specific hedge funds/offshore, industry officials reckon that there are at least 40-45 such funds. Helios Capital ($800 million), managed by Samir Arora (former chief investment officer of Allianz Capital in India) and Monsoon Capital, run by Gautam Prakash and Sandstone Capital ($700 million), are some of the funds, which have been investing in the Indian stock markets through PNs.

A Sebi executive confirmed that such a proposal was under examination, but did not give details. Sebi, on October 25, had barred issuance of P-notes by sub-accounts of FIIs, and they have been asked to wind up their current position over 18 months. Also, FIIs, which are currently issuing P-notes outstanding (excluding derivatives) as a percentage of their assets under custody in India of less than 40 per cent, shall be allowed to issue fresh P-notes only at an incremental rate of 5 percent of their assets under custody.

Following the curbs on P-note, these funds have been literally sitting idle "� neither buying nor selling "� on their existing investments. This is because, if they sell a stock, they could not buy fresh position due to the restrictions on P-notes on fresh positions. "Many hedge funds were frustrated that they could not even sell a stock which they don't like as they fear that they would reduce their India exposure as they cannot make fresh purchases due to the restrictions," said a source.

"A change in rules will allow funds to start churning their portfolio again "� that is they will make fresh purchases directly even while they sell the stocks which they don't like," explained the source.

Till now, sub-accounts "� which includes those foreign corporate, and institutions, funds or portfolios established or incorporated outside India on whose behalf investments are proposed to be made in India by a FII "� are managed and run by the FII concerned.

With an expected change in rules, sources said these funds, which rely on the stock-picking skills of these well known fund managers, can continue to operate the funds, though it is not directly managed and run by the FII.

There are 1,173 FIIs and 3,558 sub-accounts operating in the India stock market, according to Sebi. Since October 25 "� the day when P-note curbs have been put in place, about 48 new FIIs and another 108 sub-accounts have been allowed.

Currently 34 FIIs/sub-accounts issue P-notes. The notional value of P-notes has grown to Rs 3,53,484 crore as on August 2007.