Securities and Exchange Board Of India (Alternative Investment Funds) (Second Amendment) Regulations, 2023

Ankita Tiwari

30 May, 2024

The Securities Exchange Board of India (SEBI) has released the SEBI (Alternative Investment Funds) (Amendment) Regulation, 2023 vide Notification No. SEBI/LAD-NRO/GN/2023/132 dated 15^th June 2023. The SEBI (Alternative Investment Funds) (Amendment) Regulations, 2023 (Amendment Regulation, 2023) has introduced significant changes such as the introduction of a new category of Alternative Investment Fund (AIF), liquidation scheme, the compulsory appointment of a compliance officer, and the requirement to issue units in a dematerialized form. Let’s analyze these amendments in detail for better understanding.

• Introduction of a new category of AIF known as Specified Alternative Investment Fund : As per Regulation 3(4) of the SEBI (Alternative Investment Fund) Regulation 2012, there were three categories of AIFs: Category I AIF, Category II AIF, and Category III AIF. Now, with the introduction of Amendment Regulation, 2023, SEBI has inserted a fourth category of AIF known as the Specified AIF.

• Modification of the eligibility criteria of the key investment team of managers of AIF : As per Regulation 4 of the SEBI (AIF) Regulations 2012, the eligibility criteria for the key investment team of the manager of AIF was having adequate experience and at least one key personnel having experience of 5 years or more in advising or managing pools of capital or in fund or asset or wealth or portfolio management or in the business of buying, selling and dealing with securities or other financial assets. Now the same has been modified. The amended provision now requires at least one key personnel with relevant certification as may be prescribed by the SEBI from time to time. In addition to this, the requirement of having a minimum of 5 years of experience to be a member of the “key investment team” has been done away with.

• AIF shall issue units in dematerialized form : A new clause has been inserted into Regulation 10 by the Amendment Regulation, 2023 which requires every AIF to issue units in a dematerialized form subject to the conditions specified by the Board from time to time. The aim of this amendment is to:

1. Ease monitoring and administration by stakeholders and enhance transparency.
2. Reduce operational and fraud risks like fake certificates, bad delivery, delays, missing certificate, mutilation, or theft.
3. Ease transfer and transmission of securities.
4. Reduce paperwork from an administrational aspect.
5. Introduction of a liquidation scheme of AIFs

A liquidation scheme as inserted by the Amendment Regulation, 2023 means a close-ended scheme launched by an AIF to liquidate the unliquidated investments purchased from its scheme, whose tenure has expired. As per the existing norms, in the absence of consent of unit holders, the AIF was required to fully liquidate within 1 year after the expiration of the fund tenure or extended tenure. Now as per the Amendment Regulation, 2023, the liquidation would take place as per Regulation 29.

• Approval of unitholders for buying and selling investments from certain persons : The Amendment Regulation, 2023 has introduced a new clause in Regulation 15 as per which a scheme of ALF cannot buy or sell investments to and from Associates; or Scheme of AIF managed or sponsored by its Manager, Sponsor, or Associates of its Manager or Sponsor; or Investors who have committed to invest at least 50% of the corpus of the scheme of AIF, except with the approval from 75% of the investors by the value of their investment in the scheme of AIF and as per the conditions specified by the Board. Further, while obtaining approval from the investors, the investor who has committed to invest at least 50% of the corpus of the scheme of the AIF and is buying or selling the investment, from or to, the AIF shall be excluded from the voting process.

• Insertion of Chapter III-C on Corporate Debt Market Development Fund : A Corporate Debt Market Development Fund (CDMDF) is an AIF set up to make investments in terms of Chapter III-C of the Regulations. A CDMDF shall be constituted in the form of a Trust and its instrument should be in the form of a deed registered as per the provisions of the Indian Registration Act of 1908. It is a close-ended fund with a duration of 15 years from the date of its first closing. The fund can be extended and wound up with the prior approval of the Board.

• Investments in Corporate Debt Market Development Fund : Units of CDMDF shall be offered to Asset Management Companies and specified debt-oriented schemes of mutual funds. The investment shall be made in accordance with the SEBI (Mutual Funds) Regulations, 1996¹  and the manager or the sponsor will have a continuing interest in the CDMDF of not less than INR 5 crore in the form of investment in the fund but such continuing interest shall not be through the waiver of management fees.

• Eligibility criteria for the purchase of CDMDF during market dislocation:The eligibility criteria are as follows:

1. Corporate debt securities shall be listed and have an investment-grade rating
2. The residential maturity of these securities shall be not more than 5 years from the date of purchase
3. Securities where there is no possibility of default or adverse credit news or views

• Investments by CDMDF other than during the market dislocation period : Other than during the market dislocation period, the CDMDF should invest in liquid and low-risk debt instruments and undertake any other activity pertaining to the corporate debt market. During this period, the CDMDF should not invest in securities of companies incorporated outside India. Further, the investment in an investee company shall not exceed 5% of the fund capital at the time of investment.
• CDMDF Disclosure Norms :The portfolio of CDMDF shall be disclosed to the unitholders on a fortnightly basis and the net asset value of CDMDF shall be disclosed to the unitholders on a daily basis.
• Steps to comply with the governance mechanisms:

1. For compliance with the governance mechanism, the CDMDF will appoint a trustee company.
2. Prior approval from SEBI is required for the appointment of the Board of Directors of the trustee company and the Manager of CDMDF.
3. The trustee company shall only engage in activities where it acts as a trustee of the CDMDF except with prior written consent of the SEBI.
4. Two-thirds of the members of the Board of the trustee company shall be independent directors and shall not be associated with the Sponsor or Manager.
5. No person shall be appointed as the director of the trustee company without the prior approval of SEBI.
6. An audit committee of the trustee company shall be constituted to review compliance with the provisions of the placement memorandum.

• The CDMDF Governance Committee

1. The Manager of CDMDF appoints a Governance Committee.
2. The approval of all the policies of CDMDF shall be done jointly by the Governance committee, board of the Manager, and trustee company.
3. The Governance committee supervises the activities of CDMDF particularly those relating to the management of conflict of interest.
4. The Governance Committee keeps an eye on the management of asset liability mismatches during times of market dislocation.

•  Appointment of a Compliance Officer who shall be responsible for monitoring compliance : As per the Amendment Regulation, 2023, every AIF shall have a compliance officer who shall be responsible for monitoring compliance with the provisions of the Act, Rules, Regulations, Notifications, Circulars, Guidelines, Instructions, or any other directives issued by SEBI. The eligibility criteria specified by the SEBI should be satisfied by the Compliance Officer. The Compliance officer is duty-bound to immediately and independently report to SEBI about any non-compliance. Such non-compliance should be reported no later than 7 working days from the date of observing such compliance.

• Modification in the valuation procedure and of the methodology for valuing assets : As per the Amendment Regulation, 2023, it is Manager’s responsibility to ensure that the AIF appoints an independent valuer who satisfies the criteria specified by SEBI from time to time. The manager and key management personnel of the Manager shall ensure that the independent valuer computes and carries out the valuation of the investments of the scheme of the AIF in the manner specified by SEBI from time to time. The true and fair valuation of the investment of the scheme of AIF shall be the responsibility of the Manager. If an appropriate and fair valuation of the policies and procedures has not been done, then the Manager can deviate from the established policies and procedures to value the assets or securities at a fair value and document the rationale of such deviation. Further, the deviation and its rationale should be reported to the trustee or the trustee company or the Board of Directors, or designated partners of the AIF and investors of the AIF.

Bottom Line

The Amendment Regulations, 2023 have brought major changes to the SEBI (AIF) Regulations, 2012. It offers greater flexibility to deal with investments that remain unsold due to a lack of liquidity during the liquidation or winding-up process. These amendments in regulations are made to make them efficient enough to meet market conditions and remove absurdities. Further, the amendment in CDMDF will boost the confidence of the corporate bond market and encourage investor participation in the market.

Read Our Article: Foreign Portfolio Investors can Invest in Alternate Investment Funds

1. <ahref=”https://en.wikipedia.org/wiki/Securities_and_Exchange_Board_Of_India_(Mutual_Funds)_Regulations,_1996″>https://en.wikipedia.org/wiki/Securities_and_Exchange_Board_Of_India_(Mutual_Funds)_Regulations,_1996</a>