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Regulatory arbitrage is something that speculators thrive on. Investments can be based on

fundamental or technical analyses, under typical situations. Regulatory arbitrage is outside the realm

of both of these. Here, the investor is typically betting on a regulatory action by someone over

whom he has no control. There is hope that a crowd action will force the regulator to amend the

laws in a manner that does not disappoint the crowd. The investors are great believers in the adage,

that Wall Street writes the Rules.

In this instance, SEBI has stuck to its promise. Statistical evidence proves that liquidity was adequate

in the IDR and hence it did not warrant conversion. Now, there is no point in breaking down the

figures of liquidity and say that this liquidity is actually illiquid. Do we ever see a broker or an

institution using the same trading logic when it comes to midcap shares in the domestic bourses?

SEBI has not only to ensure fairness in its action as a regulator but presumably also has a

developmental role when it comes to the market and expanding the market. Besides this, it also has

a role to be equal handed when it comes to dealing with various investor classes.

There would be a hue and cry saying that SEBI will kill the future of IDR issuances. We have seen

what global depository receipts have done. Liquidity is provided by market makers. The same set ofpeople cannot now come back and say that liquidity is an issue.

When an informed investor (which most institutional investors ought to be, including the HNIs

they advice and use as parking stations for their positions many times) takes a view, surely he is

aware of the risks. At the point of investment, there are two outcomes. One is favourable and the

other is not. So, one has surely evaluated both outcomes and then placed the bet. Now, the protest

is simply because the outcome is not favourable. It is like a baby crying to acquire the latest toy.

I also do not believe that this action, will, in any way deter the issuances of future IDRs. Ultimately,

the fundamental valuation is something that should be driving the investments. This would be the

factor that brings arbitrage down to minimal levels. Arbitrage in equities ( an equity share is anequity share, whichever form it is held in) that is driven by quirks is a high risk game and beyond the

realm of investment. The regulator is not bound to protect someone who invests anticipating a

regulatory action of a particular nature.

I also believe that this is not the end of the road as far as the matter goes. Regulations are rarely

etched in stone. A good regulator will change regulations keeping in tune with the times and the

needs. Now, if everyone loses interest in the IDRs, two things should happen:

i) The instrument would become illiquid due to lack of interest and force the regulator tohave a relook at this decision;

ii) Future IDR issuances would happen factoring in the (equal) possibility of the absence ofa two way fungibility of an IDR.

SEBIs move in no way has hurt investors. Investors had the option of either buying the IDRs or the

main share. Even an Indian citizen could have bought these shares in the Hong Kong market, given

the freedom to an individual to invest in overseas funds / investment vehicles. The set of investors

who presumably bought these IDRs on the sole consideration of arbitrage have taken risks beyond

the realm of investing. It is smart money and smart money should be aware of the downsides also.

Of course, the speculators who have taken positions in the IDR will cry hoarse. However, in this

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instance, there is no case of equity or fairness that has been vitiated or violated by the regulator.

For once, the players in the market seem to have been bested. It is only because they chose to focus

only on the upside and ignore the downside. The interesting thing is that no one here seems to be

making out whether the IDR at these levels is investment worthy or not, which is what the money

managers ought to be doing instead of acting like a spoilt child.

R. Balakrishnan

June 10th, 2011