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On 18th May 2023, the Securities Exchange Board of India (SEBI) released a Consultation Paper on the proposed amendment to SEBI (Alternative Investment Funds) Regulations, 2012 (SEBI (AIF) Regulations). The purpose of this Consultation Paper is to strengthen the governance mechanism of Alternative Investment Funds (AIF). Comments and Inputs have been sought from the public and stakeholders on the proposals, which have been discussed in detail below.
Regulation 16(1)(c) and 17(c) of the SEBI (AIF) Regulations restrict Category I and Category II AIFs from borrowing funds directly or indirectly or engaging in any leverage other than to meet temporary funding requirements. It implies that Category I and Category II AIFs can be used only in exceptional circumstances to meet day-to-day operational requirements or temporary funding. It also implies that the funds cannot be used for making investments. Further, to ensure that investment opportunity was not lost by an AIF due to a shortfall in drawdown amount, Category I and II AIFs were permitted to borrow for a shortfall in drawdown subject to a condition that borrowing should not exceed 10% of the investment.
The current scenario leads to ambiguity and creates confusion in the minds of the market participants regarding the purpose for which AIFs may borrow funds. AIF borrowing is made to meet operating expenses if it is made for ‘any other purpose’ then such borrowing will be for making investments that are not permissible. Further, funds borrowed by Category I and Category II AIFs for investing in unlisted securities create a liability mismatch.
The Alternative Investment Policy Advisory Committee (AIPAC) has proposed the following amendment in this regard:
Category I and II AIFs are not permitted to borrow funds directly or indirectly or do any leverage to make investments subject to the following exceptions:
Apart from the above, AIPAC has proposed that the 30 days cooling period between two permissible periods of leverage shall be maintained.
To ease monitoring and administration by stakeholders, to protect investors against operational and fraud risk, and to maintain transparency, the AIF’s liabilities i.e. units of AIF should has been dematerialized.
As per the Depositories Act 1996, holding assets of AIFs in demat form has numerous benefits. The Companies Act 2013, the SEBI (Infrastructure Investment Trusts) Regulations 2014, and SEBI (Real Estate Investment Trusts) Regulations 2014, all require funds to be issued only in dematerialized form. AIFs have also been mandated to issue units in demat form only however, it is still under implementation.
The proposal seeks to mandate dematerialization of the AIFs asset side i.e. investments of AIF as well. The proposal seeks to mandate AIFs to hold their securities or investments in demat form other than those securities and investments where dematerialization is not available. As regard the existing investments are concerned, a period of 6 months will be provided to dematerialize investments made by AIF in such investee companies.
As per Regulation 20(11) of the AIF Regulations, a custodian was mandated to be appointed if the corpus in categories I & II AIF exceeded INR 500 crore. However, in the case of Category III AIF, a custodian is appointed irrespective of the corpus of the AIF. Appointment of custodian is done, when the sponsor or manager of Category I & II AIFs is transacting in credit default swaps, as per the terms and conditions specified by SEBI.
There was no parity across the 3 different categories of AIFs. A need was felt to appoint custodians to all AIFs irrespective of the corpus of the AIF. To ensure independent monitoring of investments of AIFs, only independent custodians should be appointed. Further, the role of the custodian with regard to monitoring investments of AIFs should be clarified in the SEBI (AIF) Regulations.
AIPAC has proposed that for the safekeeping of securities, a custodian is required to be appointed even in those cases where the corpus is less than INR 500 crore. The existing AIFs with less than INR 500 crore corpus shall be granted 6 months to appoint a custodian. Further, the custodian appointed by AIF should not be an associate of the manager or sponsor, or trustee of AIF. In the case of existing AIFs, if the custodian is an associate of the manager or sponsor or trustee of AIF, then it has to comply with the aforesaid requirement within 6 months.
In 2021 SEBI introduced the concept of LVF. LVF is a scheme of an AIF where each investor is an Accredited Investor and makes an investment of at least INR 70 crores. Accredited Investors are a class of investors who are well-informed and well-advised about investment products. Accredited Investors in general as well as in LVFs particularly have been provided with flexibility in an extension of tenure for close-ended schemes of AIFs for 2 years after obtaining the approval of 2/3rd of the unit holders by value of their investment in the scheme. Further, LVFs are permitted to extend their tenure for more than 2 years if the terms of the contribution agreement, other fund documents, and conditions specified by SEBI are fulfilled. On the expiry of the tenure or extended tenure, the AIF scheme is required to fully liquidate within 1 year.
Even though flexibility regarding extension was provided to LVFs, most of the LVFs opted for an extension of only up to 2 years. It is not feasible to provide flexibility of having no upper limit on extension as it will result in close-ended funds acquiring the nature of perpetual funds and may also lead to delayed disclosure or recognition of true asset quality, fund value, liquidity, and fund performance of AIFs and their managers. In addition to this, SEBI has also enabled a framework permitting AIFs to deal with unliquidated investments either by selling such investments to a new scheme of the same AIF or by distributing such unliquidated investments in-specie after obtaining approval of 75% of investors by value. Thus a need was felt to extend the tenure of LVFs to align them with the other schemes of AIFs.
AIPAC has proposed that LVFs can be permitted to extend their tenure up to 4 years after obtaining approval from 2/3rd of the unit holders by the value of their investment in LVF.
As per Regulation 3(7) of the SEBI (AIF) Regulations, a certificate of registration granted to an AIF is perpetual and is valid till the AIF is not wound up or the certificate of registration is not surrendered. At present, there is no requirement to pay a renewal fee for keeping the certificate of registration in force.
It was observed that many AIFs were holding certificates of registration but were not raising funds or doing any investment activity. The following issues arose when a certificate of registration was held with no activity:
As per the proposed amendment, AIF’s manager should ensure that AIF pays a renewal fee equivalent to 50% of its applicable registration fee within 3 months after the expiry of 5 years from the date of grant of registration. Those AIFs that have completed 5 years from the date of grant of the certificate will also be liable to pay a renewal fee equal to 50% of its applicable registration fee. Where an AIF fails to ensure the payment of the renewal fee then a late fee of an amount of 2% of its registration fee shall be charged for each day of delay subject to a maximum of two times of the registration fee. After this, the certificate of registration of the AIF shall be canceled or suspended. In addition to this, the AIFs shall not accept any fresh commitment or make any investment in a new investee company or launch new schemes unless the renewal fee is paid. It is the responsibility of the custodian of AIF to monitor the compliance of the aforesaid provisions by AIF or the Manager.
In summation, it can be said that the proposed amendments seek to strengthen the governance mechanism of AIF. SEBI has proposed 5 amendments to ease the operation of AIFs in India. The proposed amendment seeks to bring parity and enhance the monitoring and compliance of AIFs. In this regard, SEBI has called for inputs and suggestions from stakeholders and the public.
Read our Article:Operational Aspect of Amendment to SEBI AIF Regulations
Ankita is an Advocate and has joined Enterslice as a Legal Researcher. Her work focuses on General Civil and Commercial laws, Corporate Taxation Laws, Labour and Employment Laws and Dispute Resolution. She is a law graduate from School of Law, University of Petroleum and Energy Studies. Prior to joining Enterslice, Ankita has the experience of practicing law in Delhi and Odisha.
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