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Minformed Investing?


An article by Will McClatchy blames SEBI for being anti-foreign investors. (Hat Tip: Manish Jain)

The top gaining exchange-traded fund of 2007 is going out in style. Indian securities regulators have shut the door on all exchange-traded products, and Barclays’ iPath MSCI India Exchange Traded Note (NYSEarca:INP) is likely on the way out. Shareholders made out splendidly with 88% gains last year, but it’s a gentle reminder of how dependent exchange-traded products are on open capital markets.

In November, the Securities and Exchange Board of India announced plans to restrict offshore derivative instruments, which sounds mildly nefarious except for the fact that SEBI has made it increasingly difficult for foreigners to buy Indian stocks directly. ETFs have been out of the question; now the door is closing on ETNs, or Exchange-Traded Notes.

Blaming SEBI is easy; understand though that the ETNs themselves were to blame. SEBI had made it very clear, when it opened the door to PNs on derivatives, that there would be a five year window by which time all PN issuers would be required to name the end owners of these notes. The latest SEBI order is exactly 18 months away from that deadline, which is why PNs against derivatives have been asked to unwind in that timeframe. These ETNs conveniently forgot those rules and now hide behind the excuse of Indian bureaucracy, when it was really their problem.

Secondly, the author portrays it as a problem for ETNs per se. It is not. The issue is only for derivatives, i.e. notes against futures or options. ETN issuers can still register as FIIs (something that shouldn’t be an issue for someone like Barclays, for heavens sake) and issue notes against direct stock.

The author says “Direct stock ownership is still possible in India; just don’t try to sell in a hurry.” This is absurd. SEBI has no restrictions on selling in a hurry or rapid transactions. Nobody cares if you sell, short-sell, or buy, just do it in the right way – issuing ODIs against derivatives is a secondary market where SEBI has no regulatory control. One leg is not under SEBI’s (or anyones) regulation – and that is what they corrected. SEBI still maintains that it will offer FII status to anyone that is regulated by a body outside India.

SEBI’s decision has been endorsed by the Finance Ministry and RBI, which wants to control foreign inflows in the short term (and they’ve done so).

The article fails to notice, however, that since the “crisis”, our market has recovered, FII flows have eased back, and life is weirdly back to normal when the whole world’s heart flutters. What SEBI has done is ease speculatory flows in an environment when the pressure to liquidate (because of the subprime woes) would have been intense – note that despite the US problem, FIIs aren’t really pulling out in hordes, because if they unwound their existing notes, they don’t get to put the money back in again.

A phenomenal time to introduce this law. It’ll only work in the short term of course, because if the situation gets really bad, nobody will care about coming back in and run out the door like headless chickens.

But I can’t believe that an article would actually claim that a lassez-faire approach to regulation is the recommended course of action. The entire US crisis at this point is due to lack of proper regulation, not despite it. And some sense a few years ago would have cushioned the impact, something admitted by the US Fed themselves.

For what it’s worth, I think SEBI is restrictive even to Indian investors (for instance, you can’t have Indian Hedge funds using Indian investors’ money), and I must say I want those conditions off. We finally got the short selling rules, and I’m sure the rest will come too.


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