Sucheta Dalal :Qualifying The Quality Of Funds (3 Nov 2003)
Sucheta Dalal

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Qualifying The Quality Of Funds (3 Nov 2003)  

On October 30, the Securities and Exchange Board of India issued a clarification that was supposed to allay apprehensions about the quality of foreign funds flowing into the Indian capital market. It was also meant to ‘clarify’ or deny a news report published by a leading economic daily that it was non resident Indians who had brought in a substantial chunk of money being invested in the Indian stock market.

But SEBI’s detailed clarification only makes you wonder whether regulatory officials have made a serious effort to track foreign investment into India. The release said that total net foreign investment in India until September 30, 2003 was Rs 72,965 crore and has come in through 508 registered Foreign Institutional Investors. Earlier, chairman GN Bajpai told a TV channel that only 20 per cent of foreign investment in India, or Rs 19,000 crore was invested through Participatory Notes (PNs). This suggests that hedge funds, which were rumoured to have invested in India through PNs, could only have a maximum investment of 20 per cent. Consequently, even if these hedge funds were to pull out all their investment in a hurry, as they are globally reputed to do, it would only cause a downtrend but would not destabilise the market.

Then came a news report that nearly 40 per cent of investment into India was due to a reverse flow of capital from Indians abroad. SEBI then issued a more detailed clarification giving a break up of investment flows from various sources. It said that 84 per cent of FII investment into India came from mutual funds, asset management companies, investment companies etc. SEBI concluded that its data did not “warrant or support any inference that NRIs have contributed a substantial percentage of the outstanding FII investment”.

That may be true, but SEBI’s information raises other questions. For instance, here is the investment break-up according to the capital market regulator. Mutual funds account for 28 per cent of the total investment at Rs 20,449 crore, investment companies represent 15 per cent at Rs 10,918 crore, private companies brought in 12 per cent of the money at Rs 8,990 crore, investment advisers comprised 6 per cent at Rs 4,137 crore. Pension funds, investment trust, government and multilateral agencies and public companies accounted for 4 per cent each of FII investment bringing anywhere between Rs 2,700 to Rs 3,100 crore respectively. Unit Trusts and investment management companies investing around Rs 1,000 crore each account for 2 per cent of the total investment respectively. And insurance companies and endowment funds pushed another Rs 500 crore into the market.

The SEBI release then has a surprise package. A massive 16 per cent, or the second highest investment after mutual funds, is classified under the delightfully vague head of “others”. Are these ‘others’ the NRIs, HNIs, sharp operators that the market has been so edgy about? And isn’t 16 per cent a high enough number to cause worry, especially when every other category of investment seems to be accounted for? When asked, SEBI officials made the astounding admission that a series of tiny FII investments, had in fact, not been correctly categorised under their appropriate head and was dumped under “others”. That this number was extraordinarily large did not worry officials before releasing the information. I was told that SEBI is now “re-classifying” the data under the correct heads.

How can one then assume that other information released by SEBI is correct? Or, that the regulator has made a serious effort to check whether it includes potentially volatile investment? On seeking clarifications, we found further surprises. For instance, I was told that investment companies are only mutual funds by another name. This would mean that nearly 43 per cent of FII investment is from foreign mutual funds. Are these broad based mutual funds, or could some of them turn out to be single investor schemes, as SEBI discovered in India? The regulator does not have answers.

When asked about the nature of ‘private companies’ that account for 12 per cent of FII inflows, SEBI says they are “generally broad based, but not listed on any exchange”. Further, “the investments of private companies are routed through FIIs which are regulated entities duly registered here”. Our sources say that two unlisted investment entities floated by the Singapore government would be examples of such private companies. As opposed to this, public companies that invested just under Rs 3,000 crore are listed entities.

We were told that some investment companies have floated specific funds for investment in India, which are cleared by SEBI. The regulator did not provide any information about who the investors to these funds were, apart from the vague claim that shareholders of these ‘private’ companies are broad-based funds. When asked about “investment advisers” who have invested nearly Rs 3,000 crore in India, SEBI sources claimed that this was just another name for asset management companies — presumably as opposed to mutual funds. SEBI officials did not provide any names.

SEBI seems to derive comfort from the fact that “FIIs who are investing in Indian markets are registered and regulated by the respective overseas regulators in their home countries”. Now isn’t that funny? First Global Securities, a brokerage firm suspended by SEBI, openly issues research reports recommending investment in dubious Indian stocks, which announce that the Financial Services Authority (FSA) and the Securities Exchange Commission (SEC) regulate its two overseas companies at London and the US respectively. Neither of these regulators are yet to take cognisance of SEBI’s action against First Global despite all three being signatories to an IOSCO agreement on sharing information about regulatory action.

Anecdotal evidence from the trading community does suggest that Indian money parked in tax havens is finding its way back to here since banking secrecy laws may be repealed. But the SEBI data does not substantiate this. The question is, can we rely on SEBI’s information and investigation on the quality of FII funds coming into India? Even a cursory analysis suggests that SEBI has not done its homework and may not have all the answers. After all, in 2001, SEBI didn’t have any clue about OCBs acting as fronts for Indian businessmen and speculators until the market collapsed, the venerable Unit Trust of India went bust and politicians started making noise.

-- Sucheta Dalal