The lure of the much-feared participatory notes, through which hedge funds now invest in the Indian stock markets, may soon wane.

The Securities and Exchange Board of India, the capital markets regulator, has for the first time directly invited hedge funds to register with it and participate in the Indian stock markets without the cover of participatory notes.

Participatory notes are often seen as tools for money laundering and there have been numerous calls, including from the Reserve Bank of India, to curtail them.

It is widely estimated that 48 per cent of the $50 billion investment by foreign institutional investors in the Indian markets has come through offshore participatory notes.

Allowing hedge funds direct entry will help Sebi track the source of funds coming into the capital markets more efficiently. It is difficult to track the source of funds coming in through participatory notes.

Sebi's thinking was articulated by its chairman, M Damodaran, at a meeting organised by ICICI-Securities in Singapore early this month, which foreign investors (including several hedge funds) attended.

Sources who attended the meeting said Damodaran invited hedge funds to register with Sebi and take part in the domestic markets directly.

Globally, hedge funds, which are estimated to manage close to $1.5 trillion of assets, are known for their quick entry and exit from various asset classes, creating sharp fluctuations in prices.