Business Daily from THE HINDU group of publications
Tuesday, Mar 20, 2007
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Business Daily from THE HINDU group of publications Tuesday, Mar 20, 2007 ePaper |
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RBI & Other Central Banks Markets - Stock Markets Our Bureau
The details Hedge funds, operating outside know-your-investor norms, have long used arrangements that allow them to execute trades with several dealers. But now there is an increasing tendency on their part to consolidate the clearing and settlement of their trades through a single firm — the `prime broker'.
Dr Y.V. Reddy
Mumbai March 19 Hedge funds engaging the services of a single brokerage — prime broker — could pose greater risk to financial sector stability, according to the RBI Governor, Dr Y.V. Reddy. A prime broker acts as a settlement agent, provides custody of assets and also offers leveraged finance for hedge funds. Dr Reddy said that hedge funds, operating outside know-your-investor norms, have long used arrangements that allow them to execute trades with several dealers. But now there is an increasing tendency on their part to consolidate the clearing and settlement of their trades through a single firm — the `prime broker'. "Prime brokerage poses some unique challenge for the management and counterparty credit and operational risk. Recent events have reinforced the possible adverse impact of their risk," said Dr Reddy. Normally, in stock trading, counterparty risk is borne by clearing houses. But the liability in the event of a default by a seller or a buyer could be huge when hedge funds deal through a single broker who also provides leverage finance. Dr Reddy was speaking on `Globalisation and monetary policy' at a conference on `Advances in open economy macroeconomcis,' in Mumbai on Monday. The RBI Governor's observation assumes significance, as hedge funds operating through Participatory Notes (PN) account for nearly 50 per cent of the FII investments in Indian market. In such investments, the source of funds, or their beneficiaries, are not known. The RBI has been suspicious of the use of PNs, which is seen as a tool used for money laundering. To counter the risk of this possibility, capital market regulator SEBI is now toying with the idea of allowing hedge funds to trade in the Indian markets directly. Once registered with SEBI, hedge funds would be operating like foreign institutional investors and counterparty risk could be limited.
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