Comprehensive breakdown of SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2021– A move towards stricter governance for an emerging asset class

Introduction

With more than 700 alternative investment funds listed under SEBI and with multiple schemes being operating under  each fund, the alternative investment funds sector has started gaining recognition as a prominent asset class with increased overall participation from investors. This has led to stricter governance norms being introduced by SEBI over time with the most recent being a comprehensive list of amendments vide – Securities And Exchange Board Of India (Alternative Investment Funds) (Second Amendment) Regulations, 2021, Notification No. SEBI/LAD-NRO/GN/2021/21, dated 5th May 2021.

The notification has brought about major changes in the regulations which have broadly amended the following areas:

1. Increased scope of Investments by eliminating restricted sectors such as

  • NBFC
  • Gold Financing
  • Activities prohibited under the industrial policy of the government of India

2. Permitted investment in Fund Of Funds which was earlier prohibited.

3. Changes to the concentration rules to include indirect holding.

4. Introduction of Model Code of Conduct for:

  • Alternative Investment Funds including their key managerial personnel;
  • Investment Fund Managers and their key managerial personnel;
  • Investment Committee members and;
  • Trustees and their directors

5. Alignment of certain terms and definitions of the regulation in line with other laws.

Detailed comparison of amendments with commentary

Regulation number Old Regulation Amendment – 5th May 2021 Commentary
2(wa) “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 or such other policy of the Central Government issued in this regard from time to time;” Definition of “startup” has been added
2(aa) “venture  capital  undertaking”  means a domestic company:

(i) which  is  not  listed  on stock  exchange  in  India at  the  time of making investment; and

(ii) which is engaged in the business for providing services, production or manufacture of article or things and does not include following activities or sectors:

(1) non-banking financial companies;

(2) gold financing;

(3) activities not permitted under industrial policy of Government of India;

(4)   any   other   activity   which   may be specified by the Board in consultation with Government of India from time to time;

“venture capital undertaking” means a domestic company which is not listed on a recognised stock exchange at the time of making investments;” Prohibited sectors such as NBFC, Gold Financing and other restricted sectors have been removed.
11(2) Silent on the matter of Investment committee after the words and symbol “key service providers,” and before the words “conflict of interest”, the words and symbol “terms of reference of the committee constituted for approving the decisions of the Alternative Investment Fund,” shall be inserted The PPM to cover the terms of reference i.e the purpose, role and structure of Investment Committee (by whatever name called).
15(1)(c) Category I and II Alternative Investment Funds shall invest not more than twenty five percent of the investable funds in one Investee Company; 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; Concentration rules have been broadened to include indirect holding through another AIF.

 

15(1)(d) Category III Alternative Investment Fund shall invest not more than ten percent of the investable funds in one Investee Company 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; Concentration rules have been broadened to include indirect holding through another AIF.

 

15(1) (da) Alternative Investment Funds which are authorised under the fund documents to invest in units of Alternative Investment Funds shall not offer their units for subscription to other Alternative Investment Funds An AIF cannot act as an intermediary investment vehicle in between two AIF’s
15(1)(e) Alternative Investment Fund shall not invest in associates except with the approval of seventy five percent of investors by value of their investment in the Alternative Investment Fund; 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 units of Alternative Investment Funds managed or sponsored by its Manager, Sponsor or associates of its Manager or Sponsor

Governance check introduced for investment in AIF under the control of the same fund manager, sponsor or associates.
16(1)(a) Category I Alternative Investment Fund shall invest in investee companies or venture capital undertaking or in special purpose vehicles or in limited liability partnerships or in units of other Alternative Investment Funds as specified in these regulations; 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 Investment by Category I AIF in units of Category I AIF of same sub-category added in this sub- regulation which was covered in sub-regulation 16(1)(b) (now omitted)
16(1)(b) Fund of Category I Alternative Investment Funds may invest in units of Category I Alternative Investment Funds of same sub-category:

Provided that they shall only invest in such units and shall not invest in units of other Fund of Funds:

Provided further that the investment conditions as specified in sub-regulations (2), (3), (4) or (5) shall not be applicable to investments by such funds.

omitted Covered in regulation 16(1)(a)
17(a) Category II Alternative Investment Funds shall invest primarily in unlisted investee companies or in units of other Alternative Investment Funds as may be specified in the placement memorandum; 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;

Investment by Category II AIF in units of Category I & II AIF added in this sub- regulation which was covered in sub-regulation 17(b) (now omitted).
17(b) Fund of Category II Alternative Investment Funds may invest in units of Category I or Category II Alternative Investment Funds: Provided that they shall only invest in such units and shall not invest in units of other Fund of Funds. Omitted An AIF was earlier prohibited to invest in Funds of funds
18(a) Category III Alternative Investment Funds may invest in securities of listed or unlisted investee companies or derivatives or complex or structured products. 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 Investment by Category III AIF in units of Category I & II AIF added in this sub- regulation which was covered in sub-regulation 18(b) (now omitted).
18(b) Fund of Category III Alternative Investment Funds may invest in units of Category I or Category II Alternative Investment Funds. Omitted Has been added in revised sub- regulation 18(a).
19F (1) Angel funds shall invest in venture capital undertakings which Angel funds shall invest in “startups” the words “venture capital undertakings” has been substituted with the word “startups”. Startup has now been defined in Regulation 2(wa).
19F  (1) (a) & (b) (a) complies with the criteria regarding the age of the venture capital undertaking/startup issued by the Department of Industrial Policy and Promotion under the Ministry of Commerce and Industry, Government of India vide notification no. G.S.R. 180(E) dated February 17, 2016 or such other policy made in this regard which may be in force;

have a turnover of less than twenty five crore rupees;

Omitted Definition of “startups” introduced for Angel funds.
20 (1) All Alternative Investment Funds shall review policies and procedures, and their implementation, on a regular basis, or as a  result  of  business developments,   to ensure their continued appropriateness.

(2) The Sponsor or Manager of Alternative Investment Fund shall appoint a custodian registered with the Board for safekeeping of securities if the corpus of the Alternative Investment Fund is more than five hundred crore rupees:

Provided that the Sponsor or Manager of a Category III Alternative Investment Fund shall appoint such custodian irrespective of the size of corpus of the Alternative Investment Fund.

Provided further that the custodian appointed by Category III Alternative Investment Fund shall keep custody of securities and goods received in delivery against physical settlement of commodity derivatives.

(3) 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.

(4) In case of change in control of the Alternative Investment Fund, Sponsor  or Manager, prior approval from the Board shall be taken by the Alternative Investment Fund.

(5) The books of accounts of the Alternative   Investment   Fund   shall  be audited annually by a qualified auditor.

(6) The Manager shall be responsible for investment decisions of the Alternative Investment Fund:

Provided that the Manager may constitute an Investment Committee (by whatever name it may be called), to approve investment decisions of the Alternative Investment Fund, subject to the following:

(i) The members of Investment Committee shall be equally responsible as the Manager for investment decisions of the Alternative Investment Fund.

(ii) The Manager and members of the Investment Committee shall jointly and severally ensure that the investments of the Alternative Investment Fund are in compliance with the provisions of these regulations, the terms of the placement memorandum, agreement made with the investor, any other fund documents and any other applicable law.

(iii)External members whose names are not disclosed in the placement memorandum or agreement made with the investor or any other fund documents at the time of on-boarding investors, shall be appointed to the Investment Committee only with the consent of at least seventy five percent of the investors by value of their investment in the Alternative Investment Fund or scheme.

(iv) Any other conditions as specified by the Board from time to time Provided further that clauses (i) and (ii) shall not apply to an Alternative Investment Fund in which each investor other than the    Manager, Sponsor, employees or directors of the Alternative Investment Fund or employees or directors of the Manager, has committed to invest not less than seventy crore rupees (or an equivalent amount in currency other than Indian rupee) and has furnished a waiver to the Alternative Investment Fund in respect of compliance with the said clauses, in the manner specified by the Board.

(1) Alternative Investment Fund, key management personnel of the Alternative Investment Fund, trustee, trustee company, directors of the trustee company, designated partners or directors of the Alternative Investment Fund, as the case may be, managers and key management personnel of managers shall abide by the Code of Conduct as specified in the Fourth Schedule.

Explanation.– For the purpose of this sub-regulation, ‘key management personnel’ shall have the meaning as specified by the Board from time to time.

(2) The Manager and either the trustee or trustee company or the Board of Directors or the designated partners of the Alternative Investment Fund, as the case may be, shall ensure compliance by the Alternative Investment Fund with the Code of Conduct as specified in the Fourth Schedule.

(3) All Alternative Investment Funds shall have detailed policies and procedures, as approved jointly by the Manager and the trustee or trustee company or Board of Directors or designated partners of the Alternative Investment Fund, as the case may be, 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.

(4)   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.

(5) The Manager shall be responsible for every decision of the Alternative Investment Fund, including ensuring that the decisions are in compliance with the provisions of these regulations, terms of the placement memorandum, agreements made with investors, other fund documents and applicable laws.

(6) The Manager shall be responsible for ensuring that every decision of the Alternative Investment Fund is in compliance with the policies and procedures laid down for the Alternative Investment Fund in terms of sub regulation (3) of this regulation and other internal policies of the Alternative Investment Fund, as applicable.

(7)   The Manager may constitute an Investment Committee (by whatever name called), to approve the decisions of the Alternative Investment Fund and such constitution shall be subject to such conditions as specified by the Board from time to time.

(8) The members of the Investment Committee shall be responsible for ensuring that the decisions of the Investment Committee are in compliance with the policies and procedures laid down in terms of sub regulation (3) of this regulation:

Provided that sub-regulation (8) of this regulation shall not apply to an Alternative Investment Fund in which each investor other than the Manager, Sponsor, employees or directors of the Alternative Investment Fund or employees or directors of the Manager, has committed to invest not less than seventy crore rupees (or an equivalent amount in currency other than Indian rupees) and has furnished a waiver to the Alternative Investment Fund in respect of compliance with the said sub- regulation, in the manner as may be specified by the Board.

(9) The members of the Investment Committee shall abide by the Code of Conduct applicable to them as specified in Fourth Schedule.

(10) The external members of the Investment Committee whose names are not disclosed in the placement memorandum or in the agreement made with the investor or any other fund document at the time of on-boarding investors shall be appointed to the Investment Committee only with the consent of at least seventy five percent of the investors by the value of their investment in the Alternative Investment Fund or scheme.

(11) 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:

Provided that the Sponsor or Manager of a Category III Alternative Investment Fund shall appoint such a custodian, irrespective of the size of the corpus of the Alternative Investment Fund:

Provided further that the custodian appointed by Category III Alternative Investment Fund shall keep the custody of the securities and goods received in delivery against the physical settlement of commodity derivatives.

(12) 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.

(13) In case of change in control of the Alternative Investment Fund, Sponsor or Manager, prior approval from the Board shall be taken by the Alternative Investment Fund.

(14) The books of accounts of the Alternative Investment Fund shall be audited annually by a qualified auditor.

Newly introduced code of conduct for specified entities and persons

The Manager and either the trustee or trustee company or the Board of Directors or the designated partners of the AIF, as the case may be, shall ensure compliance by the Code of Conduct.

They will have to approve detailed policies to ensure that all the decisions of the AIF are in compliance with :

  • The provisions of these regulations,
  • Terms of the PPM,
  • Agreements  made with investors,
  • Other fund documents and applicable laws.

The Manager shall be responsible for every decision of the AIF, including ensuring that the decisions are in compliance with the provisions of these regulations, terms of the placement memorandum, agreements made with investors, other fund documents and applicable laws.

The members of the Investment Committee shall be responsible for ensuring that the decisions of the Investment Committee are in compliance with the approved policies and procedures.

The Members of the Investment Committee will also be required to abide the Code of Conduct applicable to them.

Newly introduced code of conduct under Fourth Schedule of the AIF Regulations:

Text of the newly introduced Fourth Schedule Commentary
Fourth Schedule

(1) Code of Conduct for Alternative Investment Funds

An Alternative Investment Fund shall:

(a) carry out its business activities and invest in accordance with the investment objectives stated in the placement memorandum and other fund documents.

(b) be operated and managed in the interest of all investors and not only in the interest of the sponsor, manager, directors or partners of the sponsor and manager or a select class of investors.

(c) ensure the dissemination of adequate, accurate, explicit and timely information in accordance with these Regulations to all investors.

(d) ensure the dissemination of any other information as agreed with the investors.

(e) ensure that an effective risk management process and appropriate internal controls are in place.

(f) have written policies and procedures to identify, monitor and appropriately mitigate any potential conflict of interest through-out the scope of its business.

(g) not use any unethical means to sell, market or induce any investor to buy its units.

(h) have written policies and procedures to comply with anti-money laundering laws.

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

Every Manager of Alternative Investment Funds and key management personnel of the manager and Alternative Investment Funds shall:

(a) abide by the Act, Rules, Regulations, Guidelines and Circulars as applicable to Alternative Investment Funds at all times;maintain integrity, highest ethical and professional standards in all its dealings;

(b) ensure proper care and exercise due diligence and independent professional judgment in all its decisions;

(c) act in a fiduciary capacity towards investors of the Alternative Investment Fund and ensure that decisions are taken in the interest of the investors;

(d) abide by the policies of the Alternative Investment Fund to identify, monitor and appropriately mitigate any potential conflict of interest throughout the scope of its business;

(e) not make any misleading or inaccurate statement, whether oral or written, either about their qualifications or capability to render investment management services or their achievements;

(f) record in writing, the investment, divestment and other key decisions, together with appropriate justification for such decisions;

(g) provide appropriate and well considered inputs, which are not misleading, as required by the valuer to carry out appropriate valuation of the portfolio;

(h) not enter into arrangements for sale or purchase of securities, where there is no effective change in beneficial interest or where the transfer of beneficial interest is only between parties who are acting in concert or collusion, other than for bona fide and legally valid reasons;

(i) abide by confidentiality agreements with the investors and not make improper use of the details of personal investments and/or other information of investors;

(j) not offer or accept any inducement in connection with the affairs of or business of managing the funds of investors;

(k) document all relevant correspondence and understanding during a deal with counterparties as per the records of the Alternative Investment Fund, if they have committed to the transactions on behalf of Alternative Investment Fund;

(m) maintain ethical standards of conduct and deal fairly and honestly with investee companies at all times; and

(n) maintain confidentiality of information received from investee companies and companies seeking investments from Alternative Investment Fund, unless explicit confirmation is received that such information is not subject to any non-disclosure agreement.

(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

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;

(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.

Code of conduct has been prescribed for :

  • Functioning of AIF
  • Managers of AIF
  • Key Managerial Personnel of AIF and their            managers
  • Members of the Investment Committee
  • Trustees
  • Directors of the Trustee
  • Designated partners of the AIF

Increased requirement of written policies and procedures for complying with :

  • Risk management
  • Anti Money Laundering
  • Key investment decisions along with rationale for such decisions.

Key takeaways

It is evident that SEBI aims to institutionalize the Alternative Investment Fund industry to enable greater trust from the investors which will pave way for long term growth.

The additional compliances, responsibility and requirement for policies and procedures for every stakeholder of the eco-system will develop more professionalism into the whole investment making process and will bring the domestic AIF sector closer to the international counterparts in terms of overall governance framework.

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Company: K. S. Gupta & Co
Location: Delhi, Delhi, India
Member Since: 11 May 2021 | Total Posts: 1
I am a Chartered Accountant with more than 7 years of experience of working with Big-4 assurance firms, Fortune 500 companies and handling an independent financial services practice. I have worked with a broad spectrum of business of all sizes in the service sector, manufacturing sector and startups View Full Profile

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