What is Alternative Investment Funds (AIF) ?

ALTERNATIVE INVESTMENT FUNDS

An Alternative Investment Funds (AIFs) in India are governed by the Securities and Exchange Board of India (Alternative Investment Regulations), 2012 (“AIF Regulations”) and regulated by the Securities and Exchange Board of India (“SEBI”). The AIF Regulations regulate the registration, operation and winding up of the AIFs.

1. What is an AIF?

AIF Means, privately pooled investment vehicle which collects funds from investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors. AIF can be established or incorporated in India in the form of a trust or  a Company or a Limited Liability partnership or a body corporate.

AIF does not include funds covered under the SEBI (Mutual Funds) Regulations, 1996, SEBI (Collective Investment Schemes) Regulations, 1999 or any other regulations of the Board to regulate fund management activities.

2. What is Venture Capital Fund?

VCF means AIF which invests primarily in unlisted securities of start-ups, emerging or early stage venture capital undertakings mainly involved in new products, new services, technology, or intellectual property right based activities or a new business model and also include an angel fund.

3. What are the various categories of an AIF?

• Category I AIF: This category includes AIFs which invests in start-ups, early stage venture capital projects, social venture, small and medium sized enterprises (“SME”), infrastructure projects, or other sectors which the government or regulators consider as socially or economically desirable. Category I AIFs include venture capital funds (including angel funds), SME funds, social venture funds, infrastructure funds, and special situation funds.
• Category II AIF: This category includes AIFs which does not fall in Category I AIF and Category III AIF. Category II AIFs include private equity funds (PE funds) or debt funds, for which no specific incentives or concessions are given by the government or any other regulator.
• Category III AIF: This category includes AIFs which employ different trading strategies like arbitrage, margin trading, and derivative trading. This category can make investments in both unlisted and listed derivatives through leverage as per the AIF Regulations. Category III AIFs include hedge funds or funds which trade with a view to make short term returns, etc., for which no specific incentives or concessions are given by the government or any other regulator.

4. What is open ended and close ended AIF?

AIF Regulations does not provide definition for open ended and close ended AIF. However, as per the general understanding, open-ended AIF can be understood as the scheme that offer new units to the investors on a continuous basis while, closed-ended AIF are the mutual funds, which offer new units to investors for a limited period only.

• The schemes of a Category I & II AIF are required to be close ended and shall have a minimum tenure of 3 (three) years and can be extended for period of 2 years subject to approval of 2/3 unit holders by value of their investment.
• The schemes of a Category III AIF may be open or close ended.
• Close ended can be extended for period of 2 years subject to approval of 2/3 unit holders by value of their investment.

5. Investment in Alternative Investment Fund

Investment in all categories of AIF shall be subject to following conditions:-

1. AIF may raise fund from any investor whether Indian, foreign or non-resident Indians by way of issue of Units;

2. Each Scheme of AIF shall have Corpus of atleast 20 Crore

3. AIF shall not accept from investor, an investment of less than 1 Crore, investment from employee or director of AIF or directors of Manager shall be Rs.25 Lakh.

4. Manager or Sponsor shall have investment in;

Category I & II AIF not less than 2.5% of Corpus or Rs. 5 Crore whichever is lower;

Category III AIF not less than 5% of Corpus or Rs.10 Crore whichever is lower;

1. No Scheme has more than 1000 Investors.

2. The fund will be raised only on a private placement basis.

6. Schemes of AIF

The AIF may lunch scheme subject to the filing of the Placement Memorandum with the Board through the Merchant Banker, prior to 30 days of scheme lunch.

7. Investment Conditions

• Category I AIF: A Category I AIF is not permitted to invest more than 25% (twenty-five percent) of its investable funds in a single investee company. Provided that large value funds for accredited investors of Category I AIFs may invest up to 50% (fifty percent) of its investable funds in an investee company. Category I AIF shall invest in investee companies, venture capital undertaking, special purpose vehicles, limited liability partnerships or in units of other category I AIFs of the same sub-category or in units of category II AIFs.
• Category II AIF: A Category II AIF is not permitted to invest more than 25% (twenty-five percent) of its investable funds in a single investee company. Provided that large value funds for accredited investors of Category II AIFs may invest up to 50% (fifty percent) of its investable funds in an investee company. A Category II AIF shall invest primarily in unlisted investee companies or in the units of category I or other category II AIFs.
• Category III AIF: Category III AIF is not permitted to invest more than 10% (ten percent) of the investable funds in an investee company, directly or through investment n units of other AIFs and the large value funds for accredited investors of Category III AIFs may invest up to 20% (twenty per cent) of the investable funds in an investee company, directly or through investment in units of other AIFs.

Provided that for investment in listed equity of an investee company, Category III AIFs may calculate the investment limit of 10% (ten per cent) of either the investable funds or the net asset value of the scheme and large value funds for accredited investors of Category III AIFs may calculate the investment limit of 20% (twenty per cent) of either the investable funds or the net asset value of the scheme, subject to the conditions specified by SEBI from time to time.

A Category III AIF may invest in securities of listed or unlisted investee companies or derivatives or units of other AIFs or complex or structured products or deal in goods received in delivery against physical settlement of commodity derivatives.

8. Borrowing by AIF

• Category I & II AIF: AIF shall not borrow funds directly or indirectly and shall not engage in leverage except for meeting temporary funding requirements for not more than 30 (thirty) days, not more than 4 (four) times in a year and not more than 10% (ten percent) of the investable funds.
• Category III AIF: Category III AIF may engage in leverage or borrow subject to consent from the investors in the fund and subject to a maximum limit, as may be specified by SEBI.

9. Valuation of AIF

• Category I & II AIF: Valuation of their investments needs to be done, atleast one in six months, by an independent valuer.
• Category III AIF: calculation of Net asset value (NAV) is independent from the fund management function of AIF and shall be disclosed to investor not longer than a Quarter for close ended funds and at no longer than a month for open ended funds.

10. What is the process for registration of an entity as AIF with SEBI?

The entity is required to file an application before SEBI for the purposes of registration as an AIF.

The application is to be mandatorily made in the prescribed ‘Form A’ attached in the first schedule to the AIF Regulations specifying the category under which the AIF is to be registered.

For the purpose of grant of certification, SEBI necessarily considers if the entity is permitted to carry on the activity of an AIF as per its incorporation documents and the said documents are duly filed and registered under the laws to which it is amenable. Moreover, the SEBI also considers if the applicant, sponsor, and manager are fit and proper persons based on the criteria specified in Schedule II of SEBI (Intermediaries) Regulations, 2008.

The entity is also required to submit along with the form, a copy of the draft private placement memorandum for inviting investment into the AIF to SEBI. In addition, draft formats of the investment management agreement along with the investment manager and contribution agreement with the prospective investor are also required to be submitted to SEBI at the time of registration of the AIF.

11. What is private placement memorandum? Are there any regulatory requirements in relation to an AIF’s private placement memorandum?

Private Placement Memorandum (“PPM”) is considered as the information memorandum for AIFs which contains all the necessary information about the AIFs. PPMs are required to contain all material information about the AIF including with respect to, background of the key investment team of the investment manager, targeted investors, fees and all other expenses proposed to be charged, tenure of the fund or scheme, conditions or limits on redemption, investment strategy, risk management tools and parameters employed, key service providers, conflict of interest and procedures to identify and address them and disciplinary history, the terms and condition son which the investment manager offers investment services, its affiliations with other intermediaries and manner of winding up of the AIF or the scheme.

SEBI has also released formats of PPM for each category of the AIF, which are to be followed by the prospective applicants for registration as AIFs. The formats include the minimum level of information which are required to be included in a private placement memorandum. An applicant may seek exemption from following the format in the following cases:

a) An angel fund may seek exemption from SEBI.

b) An AIF or scheme of an AIF in which each invest or commits to a minimum capital contribution of INR 700,000,000 (Indian Rupees Seven Hundred Million) or USD 10,000,000 (United States Dollars Ten Million) or equivalent, in case of capital commitment in non-INR currency.

12. Is there any dispute resolution mechanism specified under the AIF Regulations?

As per the AIF Regulations, the AIF, by itself or through its manager or sponsor is required to specify the procedure for dispute resolution arising between the investors, AIF, manager, or sponsor. The process may be through arbitration or any such mechanism as mutually agreeable between the investors and the concerned AIF.

13. What is the process for winding up of an AIF?

As per the AIF regulations, PPM of an AIF must include information on the manner of winding up of the fund. An AIF can be wound up in the following cases:

a) on expiry of the tenure of the AIF/ scheme as mentioned in the PPM;

b) if the trustee or the trustee company directs in the interest of the investors;

c) if 75% (Seventy-Five percent) of investors by the value of their investment pass a resolution for

d) winding up at a meeting of unit holders; or

e) if SEBI directs in the interest of the investors.

Further, an AIF set up as a limited liability partnership, as a company, as a body corporate shall be wound up in accordance with the provisions of the respective statutes under which they were constituted. It is the duty of the trustee or the trustee company or the director or designated partners to intimate the investors and SEBI, the circumstances leading to winding up. No investment shall be made from the fund after receiving such intimation. The assets of the AIF are required to be liquidated in accordance with the PPM and the proceeds are to be distributed among the investors after satisfying all liabilities, within 1 (one) year from the date of intimation. The certificate of registration has to be surrendered back to the SEBI on winding up.