Analysis of SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2021

Securities and Exchange Board of India vide its Gazette notification dated May 5, 2021 published its latest regulations on Alternate Investment Funds which is being reproduced below:

https://taxguru.in/sebi/sebi-alternative-investment-funds-second-amendment-regulations-2021.html

e-gazette deals with some basic information on alternative invest funds.

Let us discover the latest instructions on alternate investment funds (AIFs) as under: (Though new instructions have been quoted directly, detailed discussions will take place at the end of this article.)

  • Let us learn some new definitions introduced in above notification on start-up, venture capital undertaking, investments to be made by category 1, 2, 3 of alternate investment funds (AIF).
  • “startup” means a private limited company or a limited liability partnership which fulfills the criteria for startup as specified by the Department of Promotion of Industry and Internal Trade, Ministry of Commerce and Industry, Government of India vide notification no. G.S.R. 127(E) dated February 19, 2019.
  • “venture capital undertaking” means a domestic company which is not listed on a recognized stock exchange at the time of making investments.
  • Category I and II of Alternative Investment Funds shall invest not more than twenty-five per cent of the investable funds in an Investee Company directly or through investment in the units of other Alternative Investment Funds.
  • Category III of Alternative Investment Funds shall invest not more than ten per cent of the investable funds in an Investee Company directly or through investment in units of other Alternative Investment Funds.
  • Where does AIF invest?
  • Detailed instructions read as under:
  • Alternative Investment Funds which are authorized under the fund documents to invest in units of Alternative Investment Funds shall not offer their units for subscription to other Alternative Investment Funds.

Whose approval is required for investment in AIF? Alternative Investment Fund shall not invest except with the approval of seventy five percent of investors by value of their investment in the Alternative Investment Fund in –

(a) associates; or (b) units of Alternative Investment Funds managed or sponsored by its Manager, Sponsor or associates of its Manager or Sponsor.

Category I Alternative Investment Fund or Category II Alternative Investment Funds will invest in what types of companies?

Category I Alternative Investment Fund shall invest in investee companies, venture capital undertakings, special purpose vehicles, limited liability partnerships or in units of other Category I Alternative Investment Funds of the same sub category.

Category II Alternative Investment Funds shall invest in investee companies or in the units of Category I or other Category II Alternative Investment Funds as may be disclosed in the placement memorandum;

Explanation. – Category II Alternative Investment Fund shall invest primarily in unlisted companies directly or through investment in units of other Alternative Investment Funds.

What about Category III Alternative Investment Funds?

Category III Alternative Investment Funds may invest in securities of listed or unlisted investee companies, derivatives, units of other Alternative Investment Funds or complex or structured products.

What about code of conduct by AIF?

The Manager and either the trustee or trustee company or the Board of Directors or the designated partners of the Alternative Investment Fund, (Controllers) as the case may be, shall ensure compliance by the Alternative Investment Fund with the Code of Conduct as specified in the Fourth Schedule. SEBI has defined key management personnel in its earlier instructions which remain the same. It is also to be enforced here that KEP or their managers would invariably abide by Code of Conduct. (I have used the word controllers for convenience; not used in notification)

What about detailed policies and procedures and who would enact it?

All Alternative Investment Funds shall have detailed policies and procedures, as approved jointly by the Manager and controllers, to ensure that all the decisions of the Alternative Investment Fund are in compliance with the provisions of these regulations, terms of the placement memorandum, agreements made with investors, other fund documents and applicable laws.

AIF to review the policies and procedures regularly for their relevance in continued business operations.

All Alternative Investment Funds shall review the policies and procedures laid down in terms of sub regulation (3) of this regulation, other internal policies, if any, and their implementation, on a regular basis or as a result of business developments, to ensure their continued appropriateness.

The manager of AIF to be responsible for:

  • To ensure all decisions of AIF are in terms of policies and procedures
  • To constitute an investment committee to approve the decisions of AIF in terms of Board of Directors’ directions and the members of investment committee to ensure the investments are in terms of applicable policies and procedures.
  • In case where each investor agrees to invest Rs 70 Crores the above guidelines would not apply.
  • The members of investment committee have to be approved by minimum of 75% of investors by value of their investment in AIF.
  • The Sponsor or Manager of the Alternative Investment Fund shall appoint a custodian registered with the Board for safekeeping of the securities if the corpus of the Alternative Investment Fund is more than five hundred crore rupees.
  • However, in case of AIF Category 3, their appointment can be done by the manager or the sponsor of the funds.
  • We have been further informed that All Alternative Investment Funds shall inform the Board in case of any change in the Sponsor, Manager or designated partners or any other material change from the information provided by the Alternative Investment Fund at the time of application for registration.
  • For a change in control of AIF, the approval of Board approval is required.

Economic Times and a few other news papers started discussion with audit of AIF which is being given below the required importance.

The books of accounts of the Alternative Investment Fund shall be audited annually by a qualified auditor. (I intend discussing this at end)

Now detailed information in respect of (

1. Code of conduct for AIF,

2. Code of Conduct for the Managers of Alternative Investment Funds and key management personnel of Managers and Alternative Investment Funds, (Controllers) and

3. Code of Conduct for members of the Investment Committee, trustee, trustee company, directors of the trustee company, directors or designated partners of the Alternative Investment Fund (Investment committee and others).

4. These are given under Fourth Schedule, SEBI (Alternative Investment Funds) Regulations, 2012 [Regulation 20(1) and 20(9)]

Let us learn the salient features of Code of conduct from Fourth Schedule, SEBI (AIF) Regulations:

1. Code of conduct for AIF

(a)  To maintain integrity and the highest ethical and professional standards of conduct, dissemination of proper information timely, to all investors, to create an effective risk management policy and enforce through effective internal controls, and not to use any unethical means to sell, market, or induce any investor to buy its units and definitely have written policies and procedures to comply with anti-money laundering laws

(b) ensure proper care and exercise due diligence and independent professional judgment in carrying out their roles;

(c) disclose details of any conflict of interest relating to any/all decisions in a timely manner to the Manager of the Alternative Investment Fund, adhere with the policies and procedures of the Alternative Investment Fund with respect to any conflict of interest and wherever necessary, recuse themselves from the decision-making process;

(d) maintain confidentiality of information received regarding the Alternative Investment Fund, its investors and investee companies; unless explicit confirmation is received that such information is not subject to any non-disclosure agreement.

(e) not indulge in any unethical practice or professional misconduct or any act, whether by omission or commission, which tantamount to gross negligence or fraud.

2. Code of Conduct for the Managers of Alternative Investment Funds and key management personnel of Managers and Alternative Investment Funds:

  • to have the highest integrity, follow high ethical standards and exercise high professional   standards in working.,
    • to act in a fiduciary capacity towards investors of the Alternative Investment Fund and ensure that decisions are taken in the interest of all investors,
    • to abide by AIF policies to avoid potential conflict of interest, to communicate actual qualifications or capability while rendering investment management services, put it on record the actual investment decisions along with justifications, to eliminate beneficial interest of benefits to interested parties in investment decisions, keep confidential agreements safe and protect the personal/other information of investors, not to allow any inducements in business, and by maintaining very high ethical standards and maintain fair dealings with all investee companies, and companies seeking investments from AIF.
    • Managers and key management personnel of managers and AIF to totally abide by rules, regulations, Act, etc., applicable to AIF

3. Members of the Investment Committee, trustee, trustee company, directors of the trustee company, directors or designated partners of the Alternative Investment Fund shall

(a) maintain integrity and the highest ethical and professional standards of conduct, exercise due diligence and independent professional judgement.

(b) Avoid conflict of interest situations or follow strictly the laid down policies of AIF in this regard

(c) Maintain confidentiality of information in all situations and maintain terms of non-disclosure agreement terms, not indulge in any illegal or fraudulent activities  

 Discussion

It is obvious from above detailed instructions that code of conduct, written policies and procedures in writing, working of investment committee without favoring any sponsor and placement of investment in terms of laid down guidelines, strict observance of anti-money laundering laws and other working of AIF would be subject to auditing and auditors would insist on written down documents and study observance of policies and procedures in practice. We learnt that if any investor invests Rs 70 Crores or more, the approval of investment committee recommendations need not be obtained. Auditors would love to look into various situations to verify observance of professional standards, highest standards of integrity and equal treatment to all investors as per rules as per the auditing procedures. Anti – money laundering laws are now part of auditing profession in all their assignments.

Since many high-net-worth investors use Alternate Investment Fund, this article was written. If many of investors do gain any benefits by SEBI notifications, the real purpose of investments would be served.  

I would love to get information from leading auditors who do undertake audit of Alternate Investment Funds. They can comment or write more articles.

Let me incorporate some questions and answers from SEBI web publication for our knowledge.

https://taxguru.in/sebi/faqs-sebi-alternative-investment-funds-regulations-2012.html

FREQUENTLY ASKED QUESTIONS (FAQs) SEBI (ALTERNATIVE INVESTMENT FUNDS) REGULATIONS, 2012 (from above website only)

Disclaimer: These FAQs are prepared with a view to guide market participants on SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”).

What is an Alternate Investment Fund (“AIF”)? Alternative Investment Fund or AIF means any fund established or incorporated in India which is a privately pooled investment vehicle which collects funds from sophisticated investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors.

2. In what categories can an applicant seek registration as an AIF? Applicants can seek registration as an AIF in one of the following categories, and in sub-categories thereof, as may be applicable: [Ref. Regulation 3(4)]

  • Category I AIF: o Venture capital funds (Including Angel Funds) o SME Funds o Social Venture Funds o Infrastructure funds
  • Category II AIF
  • Category III AIF

3. What are Category I AIFs? AIFs which invest in start-up or early-stage ventures or social ventures or SMEs or infrastructure or other sectors or areas which the government or regulators consider as socially or economically desirable and shall include venture capital funds, SME Funds, social venture funds, infrastructure funds and such other Alternative Investment Funds as may be specified. [Ref. Regulation 3(4)(a)]

4. What are Category II AIFs? AIFs which do not fall in Category I and III and which do not undertake leverage or borrowing other than to meet day-to-day operational requirements and as permitted in the SEBI (Alternative Investment Funds) Regulations, 2012. [Ref. Regulation 3(4)(b)] Various types of funds such as real estate funds, private equity funds (PE funds), funds for distressed assets, etc. are registered as Category II AIFs.

5. What are Category III AIFs? AIFs which employ diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives. [Ref. Regulation 3(4)(c)] Various types of funds such as hedge funds, PIPE Funds, etc. are registered as Category III AIFs. For detailed and more information, the website quoted may be referred.

Disclaimer: The contents of this article are for information purposes only and do not constitute an advice or a legal opinion and are personal views of the author. It is based upon relevant law and/or facts available at that point of time and prepared with due accuracy & reliability. Readers are requested to check and refer relevant provisions of statute, latest judicial pronouncements, circulars, clarifications etc. before acting on the basis of the above write up.  The possibility of other views on the subject matter cannot be ruled out. By the use of the said information, you agree that Author/TaxGuru is not responsible or liable in any manner for the authenticity, accuracy, completeness, errors or any kind of omissions in this piece of information for any action taken thereof. This is not any kind of advertisement or solicitation of work by a professional.

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