The Securities and Exchange Board of India (SEBI) has released five consultation papers on Alternative Investment Funds (AIFs) in India, regarding investor consent in related party transfers, relaxation of eligibility criteria for key persons, dematerialization mandate for units of AIFs, extension of time periods and transfer to new scheme for expiring AIFs and regarding elimination of double charges for investors in placement of AIF units.
With the increasing traction of AIFs as an investment option, the consultation papers provide a valuable resource for investors, fund managers, and other industry participants to better understand the regulatory landscape in India. In this blog, we will examine the key provisions and proposals outlined in each of the five SEBI consultation papers on AIFs, and explore the implications for the Indian investment landscape vis-à-vis the similar in other jurisdictions mainly Luxembourg.
1. Consent of Investor(s) in Transfer of Securities between Related Fund/s
|
Present Scenario |
Presently, to manage conflicts of interest for investors, SEBI requires investor consent only when investing in associates. When availing services from associates, the fees paid must be disclosed to investors. |
| Proposed | To address potential conflicts of interest, SEBI proposes extending the requirement of investor consent to cover investments made in associates, as well as buying or selling securities from or to associates and schemes of AIFs managed or sponsored by the same manager or sponsor or their associates. |
| Practical Implication | An Investor X has units of ‘AIF A’ which is managed/sponsored by same manager/sponsor as of ‘AIF B’. In current regulatory scheme, there is no bar on transfer of securities between AIF A and B.
The proposal makes it mandatory to take 75% shareholder (by value) approval for such transfers. |
| Comparative Analysis | In accordance with Luxembourg Law of 12th July, 2013 (AIFMs), there is no such restrictions on transfers, rather the mandate is to have in place, an internal ‘Conflict of Interest’ policy (as per Law of 17 December, 2010) which allows for such provisions to be put at discretion of the fund i.e. bent towards self-regulatory principles. |
| Remark(s) | SEBI in its paper has compared PMS and Mutual Funds, which seems unjust, since the very purpose of an AIF not being a MF or a PMS activity is the risk appetite of investors. Such an act, of mandating approvals may delay the processes in environments which are dealing with utmost risk and are time sensitive, further, such action, which are unlike laws of other countries having AIF regimes, shall impediment the growth of AIF industry in India and may make investors planning to set up AIFs frown on legislative compliance hurdles.
It is recommended that: 1. There can be complete exemption if the shareholders of two funds are similar, and such activity is merely strategic in nature. 2. AIFs are private in nature – therefore just like member-broker or alike agreements, such clauses can be made optional at discretion of investor and the AIF manager. Also, the domain of AIF by virtue of its entry barrier by amount makes a deemed assurance of a high value investor who shall have ability to have in knowledge such clauses etched in the contractual agreement. 3. Even if, such a mandate is made mandatory, its time period must be shortened so as to avoid time hurdles. |
2. Relaxing Eligibility Criteria of Key Investment Team
|
Present Scenario |
Regulation 4(g) of SEBI (AIF) Regulations, 2012 mandate an AIF manager to have specified qualifications, as per SEBI this has two impediments:
1. Barrier for new age/first generation managers. 2. Confusion amongst legal team(s) and need of SEBI to respond vide observations. |
| Proposed | To enhance the experience criteria for the key investment team member(s) of an AIF manager, SEBI proposes replacing it with the requirement of obtaining relevant certification from a SEBI-notified institution. Additionally, the compliance officer of the AIF manager may also be required to obtain similar certification. |
| Practical Implication | National Institute for Securities Markets (NiSM) or Indian Association of AIFs (IAAIF) may be notified just like AMFI and Series V-A Certification in case of Mutual Funds. |
| Remark(s) | 1. SEBI has rightly noted that even Mutual Fund does not have such barrier restrictions.
2. SEBI has acknowledged the very substance which it should for other papers to, i.e. AIF is a game of sophisticated investors who can for themselves, adjudge the manager and further there is already mandatory disclosure for biography of manager. 3. SEBI’s step can be noted to be more freely allowing disclosure and self-regulatory regime than pro-regulatory regime. It is further recommended that: Such notified agency can be considered a one, other than NiSM, since AIF has a foreign traction, NiSM is too Indic based with multiple requirements which may make it difficult for foreign managers to get certifications with requirements such as offline tests etc. |
3. Dematerialized form to issue AIF Units
|
Present Scenario |
Currently, it is a matter of choice of AIF unit holders to have their units either in physical form or dematerialized form. According to SEBI, most of these units are in non-dematerialized form, and it lists multiple reasons for the same. |
| Proposed | To make dematerlization mandatory for AIFs initially for funds having corpus of more than Rs. 500 Crores, holders including Foreign Investors to mandatorily open a Demat account. |
| Practical Implication | 1. Existing AIF Unitholders would need to dematerialize their holdings as well.
2. Foreign investors would need to open Demat account to hold the units. 3. Transferability of the units shall be as per Private Placement Memorandum (PPM) and terms as agreed upon. |
| Comparative Analysis | Luxembourg’s Law of 6 April, 2013 also provides an option for optional dematerialization. But, such dematerialization isn’t strictly controlled by depository system as in India.
It has technological options like Digital Ledger Technology and others for the issuance of dematerialized form of AIF units. |
| Remark(s) | 1. SEBI recognizes in the paper that the AIFs have sophisticated investors (who do have this choice of dematerialization but are unwilling to exercise so) – but is reluctant to give a free hand and in contrast wishing to hand unwanted “benefits” of dematerialization.
2. Such quest for standardization, especially having foreign investors open demat account shall hit ease of doing business – another fact which SEBI has recognized in the very paper, but still wishes to go ahead. 3. In real time, the fundamental reason of dematerialization had been fraudulent activities and inefficient deliveries with multiple loopholes. AIFs have minimal transferability provisions unless provided by PPM and it is again an unexercised choice in hands of the sophisticated investors. 4. SEBI has itself pointed plethora of reasons to justify the data of unexercised options of dematerialization, but the contrary benefits of dematerialization seem too naïve to be imposed mandatorily on investors. |
4. Extension or Transfer to New Scheme on Expiry of Earlier AIF
|
Present Scenario |
1. According to Regulation 13(5) of AIF Regulations, AIFs/Managers have the option to extend the tenure of a scheme for up to two years with the approval of two-thirds of the investors by value of their investment.
2. As per Regulation 29(8) of AIF Regulations, AIFs/Managers have the option to distribute the assets of the AIF in-specie after obtaining approval of at least 75% of the investors by value of their investment. 3. If neither of the above consents is received or if the two-year extension is completed without investor approval, as per the same regulation, the AIF shall fully liquidate the scheme within one year. 4. Large Value Funds for Accredited Investors (LVF) can extend the tenure beyond two years, as per the terms of the contribution agreement and other fund documents, and subject to conditions specified by SEBI from time to time. If the conditions specified in the placement memorandum, contribution agreement, or other fund documents for extension of tenure beyond two years are not fulfilled, LVF shall fully liquidate in accordance with AIF Regulations. |
| Proposed | 1. AIF/Manager to arrange bids for atleast 25% of unliquidated investments and offer pro-rata exit to all existing unit holders who choose to redeem their units through this option.
2. In case of inability to exercise the above – closing valuation of AIF based on the liquidation value as determined under IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, or other applicable IBC norms. 3. The new investors of the new fund, shall be informed explicitly about the carry over. 4. Such new fund – if formed for the purpose of transfer, shall be exempt from: a. Minimum scheme corpus requirement [Regulation 10(b)and Regulation 19L(1)] b. Minimum investment requirement from investor in scheme of AIF [Regulation 10 and Regulation 19L(2)] c. Requirement of fixed tenure [Regulation 13(1)] d. Investment concentration norms [Regulation 15(1)(c)] |
5. Eliminating Double Commission Charges
|
Present Scenario |
Investors who invest in an AIF through an Investment Adviser or Portfolio Manager may face double charges – an advisory fee or portfolio management fee from the advisor/manager, and a separate AIF distribution fee. |
| Proposed | 1. Direct Plan to be mandatory entailing no distribution/ placement fee.
2. AIF shall ensure that in case intermediary charges a fee, then AIF shall route the investment through direct plan only. 3. Investors in Category III AIFs may be charged placement/ distribution fees on a trail basis, while those in Category I and II AIFs may also be charged on a trail basis but with the possibility of paying a higher upfront fee (one-third of the total distribution fee). |
| Remarks | The rationale of this is to reduce mis-selling, upfront commissions and decrease multiplicity of commissions charged to change the model that is tilted towards advisors and managers currently. |
Varun Matlani is a student of law at Gujarat National Law University & CA (Intermediate)
Author Bio
