India's appeal to foreign investors has soared in line with its GDP growth rates over the past decade, but the slow pace of regulatory change has left some institutional investors frustrated at the cost and effort of trading stakes in local firms.
Like other BRIC countries, India's desire to draw on international capital flows has been tempered by its awareness of the volatility and disruption that can result from foreign participation in domestic financial markets. Increased ease of foreign access to India's equity markets may be decided by the outcome of the battle between irresistible competitive forces and immovable regulatory will.
In 1992, India introduced P-Notes (participatory notes), a type of single-stock issued by registered foreign institutional investors (FII) to overseas investors rather than permitting direct purchase of locally-traded stock. These proved hugely successful, especially with hedge funds, but the anonymity and absence of regulatory burdens afforded to global investors by P-Notes led to fears of potential abuse and volatility locally. In October 2007, the Securities and Exchange Board of India (SEBI) restricted issuance of new P-Notes by FIIs to no more than 40% of their assets under custody. The result was a steep decline in foreign investment in Indian stocks which did not recover fully even when restrictions were relaxed. According to the regulator's own figures, P-Notes accounted for 15% of Indian investments via FIIs in August 2009, compared to 51% in September 2007.
Regulatory restrictions have also had an impact on the use of electronic trading techniques by international investors to trade Indian stocks. Direct market access, for example, is not as common a means of trading into India as elsewhere in Asia. Because SEBI requires that buy-side firms submit information about the sub-accounts to which trades will be allocated in advance, many international investment institutions end up using a ”one-touch' rather than true DMA approach in India.
Research consultancy Celent recently estimated that just 2% of trades executed by institutional brokerages in India were conducted via DMA in 2008. But the growing competitiveness of domestic brokerages against global sell-side firms and a gradual acceptance by local investors of the benefits of DMA (i.e. lower costs through higher levels of automation) are likely to drive that figure much higher. In its April 2010 report, ”Institutional brokerages in India', Celent predicted that DMA would account for 10% of institutional brokerage volumes by the end of 2010, rising to 35% by 2015, as part of an overall increase in electronic trading in India by both foreign and domestic firms. “FIIs already have begun using electronic trading on a regular basis, and the DIIs (domestic investment institutions) such as the mutual funds also have the technology and processes in place,” the report reads.
But given that DMA levels for Australia, Hong Kong, Japan and Singapore, are forecast to rise to between 20% and 35% by 2012, India may need to take a more relaxed regulatory climate to catch up with Asia's more mature electronic trading markets.
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