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CECA and Its Applicability to Hedge Funds
Leena Pinsler1 , Head of South Asia Practice
Rajah & Tann
September 2005


This article analyses the applicability of the Comprehensive Economic Co-operation Agreement signed between Singapore and India against the backdrop of the current regulatory regime for hedge funds in India. It examines in particular the benefits of listing hedge funds on the Singapore Exchange.

1. Introduction

The Comprehensive Economic Co-operation Agreement ("CECA") between Singapore and India is the first of its kind that India has signed with any country as well as the first that Singapore has signed with a developing country. CECA integrates agreements on trade in goods and services, investment protection and promotion and economic cooperation in fields like education, intellectual property, science and technology.

2. Benefits under CECA

2.1 Capital Gains Exemption

The understanding reached on CECA has also resulted in an improvement to the Double Taxation Avoidance Agreement between Singapore and India. The Protocol gives Singapore residents a status comparable to that given to residents of Mauritius ie whereby capital gains may be remitted from India free of Indian withholding tax. However, for Singapore residents to qualify for the capital gains exemption, a resident must not be a shell/conduit company with nil/negligible operations or with no real and continuous business activity carried on in Singapore. A company has been given a broad definition and could include other entities such as funds.

A Singapore tax resident is deemed not to be a shell/conduit company if:

i. it is listed on the Singapore Exchange ("SGX"); or

ii. has an annual operating expenditure of at least SGD 200,000 or Rs. 5,000,000 in the last 24 months preceding the capital gains.

A separate condition is that a Singapore resident may not be permitted to claim the benefit of the exemption where the affairs of the resident are primarily arranged to take advantage of the capital gains exemption. However this condition is explained to cover cases of legal entities not having bona fide business activities. The phrase "arranged with the primary purpose to take advantage of the benefits in Article 1" has not been defined. It remains to be seen whether Indian tax authorities come out with guidance notes to clarify its application.

The concession granted to Singapore, with reference to capital gains exemption, will remain valid so long as the same treatment is available under the India-Mauritius DTAA. While critics of CECA feel that the limits on the Singapore treaty make it less efficient than the Indo-Mauritius DTAA, it should be noted those limits on CECA were inserted to stem abuse of the kind seen in the case of the India-Mauritius DTAA where mail-box companies were established. India is under tremendous pressure to review the capital gains exemption terms it has with Mauritius. Accordingly, it might be a short-term strategy to use Mauritius for new investments.

2.2 Increase in permissible investment limits of equities and instruments listed on SGX

CECA provides two primary benefits in relation to SGX-listed instruments (including hedge funds):

i. Securities and Exchange Board of India ("SEBI") regulated funds managed by asset management companies ("AMCs"), owned or controlled by India or Singapore juridical persons and intermediaries, may offer SGX-listed mutual funds and CIS (including hedge funds) to Indian investors without the limitation that the company in which investments are made should have a stake in an Indian company; and

ii. AMCs established in India, which are owned or controlled by Singapore or India juridical persons, may invest an additional US$250 million in SGX-listed equities and instruments above the usual ceiling of US$1 billion that Indian AMCs may invest abroad.

2.3 Listing of hedge funds in Singapore

In light of the CECA benefits, hedge funds may consider an SGX listing both:

i. to qualify for exemption from Indian tax on capital gains made by the hedge fund; and

ii. as an avenue for tapping Indian investor demand for hedge funds.

Hedge funds would generally be regarded as collective investment schemes ("CIS") in Singapore. The Monetary Authority of Singapore ("MAS") has essentially gone the way of most regulators in allowing hedge funds to remain largely self-regulated unless they are to be offered to the public. Where CIS are to be offered to the public or any section of the public, they would have to be "authorised" if constituted in Singapore or "recognised" if constituted outside Singapore. There is also an abridged procedure for restricted recognition where the CIS are only to be offered to sophisticated investors.

Hedge funds can seek a primary or secondary listing on the SGX. Like the MAS, the SGX has also taken a reasonably flexible approach to regulating listed hedge funds, allowing listed hedge funds leeway in how they manage their assets, whilst mandating standards that ensure that investors in listed hedge funds are made fully aware of the risk of losing all or part of their investment, and setting disclosure standards that are capable of fully and frankly informing investors of a listed hedge fund's investment performance and management standards.

The SGX's regulatory regime for hedge funds is comparable to that of the Irish Stock Exchange which currently attracts several hedge fund listings. The SGX in comparison places minimal investment restrictions on hedge funds.

3. The Indian regulatory framework regarding hedge funds

3.1 SEBI (FII Regulations), 1995

Hitherto, there have been many pitfalls in the mode of operation of hedge funds in India. For instance, hedge funds generally do not approach SEBI for registration as FIIs under the SEBI (FII Regulations), 1995 ("Regulations") as they are unlikely to satisfy the eligibility criteria.

The reason for this is that the eligibility requirements for FII applicants which SEBI takes into consideration are:

i. Applicant's track record2, professional competence, financial soundness, experience, general reputation of fairness and integrity;

ii. Whether the applicant is registered or regulated by an appropriate Foreign Regulatory Authority in the same capacity in which the application is filed by SEBI;

iii. Whether the applicant is a fit and proper person.

However hedge funds can enter the Indian market through the FII sponsored sub-account route. Under the Regulations, foreign corporates, foreign individuals, proprietary fund of FIIs and institutions or funds or portfolios established outside India, whether incorporated or not, can get registered as sub-accounts. The FII is required to apply on behalf of the sub-account with both signing the application form. The validity of the sub-account registration is thus co-terminous with the FII registration under which it is registered. However, it should be noted that SEBI has in the past withheld approval of sub-account applicants having characteristics similar to a hedge fund According to SEBI figures, on the basis of market value, the hedge funds account for about five per cent of the market value of the total assets held by the FIIs in India.

3.2 Participatory Notes

Under the current regime, hedge funds operate either through the sub-account route or through the more popular Participatory Notes ("P-Note") route. P-Notes are offshore derivative instruments in the form of contract notes issued by registered FIIs against underlying securities to overseas investors. The reason for the popularity of P-Notes is that it allows for foreign funds to flow in without the identity of the actual overseas investor being disclosed to SEBI. The way P-Notes function is quite simple: the investors place their order through brokerage houses that enjoy FII status. The brokerage houses then repatriate the dividends and capital gains back to these entities. The broker executes the trade on its proprietary trading account thereby keeping the investor's name anonymous.

The reason given by the foreign hedge funds for use of P-Notes in India is threefold. First, there is the problem of regulatory delay since it is highly probable that a new fund will not get registration as an FII and, even if it could, it will take at least 4 weeks to obtain such registration. This lag time is very inefficient for investment in capital markets which react on a daily basis. It is simpler therefore, to sign a P-Note contract despite the fact that it is more expensive from a trading point of view and very illiquid. The second reason for opting for P-Notes is the freedom and flexibility to trade in a few stocks rather than be obliged to comply with the SEBI-imposed requirement to invest in a broad market of 30-40 different stocks. The final factor for opting for P-Notes is the disclosure regime as P-Notes are only monitored by SEBI on an extremely limited basis:

i. FIIs/sub-accounts which issue/renew/cancel/redeem P-Notes are required to report to SEBI on a monthly basis;

ii. FII/sub-accounts merely investing or subscribing to the P-Notes/Access Products/Offshore Derivative Instruments or any other such type of instruments/securities with underlying Indian market securities are required to report on a quarterly basis;

iii. FIIs/sub-accounts who do not issue P-Notes but have trades or hold Indian securities during the reporting quarter require to submit 'nil' undertaking on a quarterly basis;

iv. FIIs/sub-accounts who do not issue P-Notes and do not have trades or hold Indian securities during the reporting quarter are not required to make any report for that particular quarter.

3.3 SEBI Task Force Report

With a soaring market, healthy foreign exchange reserves, and stronger institutional framework in the capital markets (as compared with the rest of Asia), India has finally taken a more favourable view towards hedge funds. The biggest reason for such a mindset shift is that hedge funds are becoming the favoured investment vehicle for serious investors in the US and the single largest source money from foreign institutional investors. Hedge funds have been collecting more money than mutual funds reflecting that more investible funds are being channelled through them. This has finally galvanised India's market regulator, SEBI, to come out with a draft report on 24 May 2005 ("Report") for a proposed regulatory framework for registration of hedge funds in India.

The Report, while identifying the lack of a definition of hedge funds under any law, has pointed out that these could loosely be termed as unregistered private investment partnerships, funds or pools that may invest and trade in different markets and are not subject to any regulatory requirement in their home country.

The Report is a consequence of SEBI trying to find a workable solution to the problem at hand and allowing hedge funds to register directly with it instead of through the P-Note route. At the end of March 2004, total investment by hedge funds in offshore derivative instruments (participatory notes) against Indian equity was Rs 8,050 crores. The key recommendations of the Report include:

i. The investment advisor to the hedge funds should be regulated investment advisors "under the relevant Investor Advisor Act or the fund should be registered under the Collective Investment Fund Regulations or Investment Companies Act;

ii. The fund should be broad-based, that is, it should invest in a basket of 30-40 stocks. The rationale behind this recommendation is that hedge funds seeking absolute returns usually invest in a few stocks while the Regulations require a more broad-based investment philosophy;

iii. The fund manager or investment advisor must have a minimum three-year track record in managing funds with an investment strategy that is similar to that of the applicant fund. The rationale for this is to keep the Indian markets insulated from the trial and errors of new entrants and encourage well managed funds;

iv. At least 20% of the corpus of the hedge fund, seeking to register in India as an FII, should have been contributed by pension funds, university funds, charitable trusts, endowments, banks and insurance companies. The presence of institutional investors in the fund is expected to ensure better governance on the part of the fund manager and fund administrators. The rationale behind this recommendation is that institutional investors may help fund managers to take a long term perspective of the market;

The Report, while recommending that hedge funds be afforded a limited opportunity to invest in the Indian equity markets, also recommends that they should still not be allowed to invest in commodity and currency markets in India. The Report has also proposed an additional limitation on hedge funds by recommending that they will not be allowed to engage in the short-selling strategy in the Indian stock markets. According to the recommendation, all transactions must have a delivery dimension.

There is no indication at this stage as to when the proposals, made in the Report, will be implemented.


1 The author heads the South Asia practice at Rajah & Tann. The author would like to acknowledge the contributions of Nisha Kaur Uberoi and Abhishek Singh.
2 It is necessary for the applicant to have at least a one year track record.

Disclaimer: The information contained in this article is correct to the best of our knowledge and belief at the time of writing. The contents of the above are intended to provide a general guide to the subject matter and should not be treated as a substitute for specific professional advice for any particular course of action as the information above may not necessarily suit your specific business and operational requirements. It is to your advantage to seek legal advice for your specific situation. In this regard, you may call the lawyer you normally deal with in Rajah & Tann or e-mail the Knowledge & Risk Management Group at

If you have any comments about or contributions to make to this newsletter, please email


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