“Standardisation is the first step in bringing transparency and competitiveness in any activity.” With the goal set for making the Indian AIF industry a globally competitive one, the chief regulator SEBI, on January 6, 2023, released a consultation paper to impart the flavor of standardisation in the yet extremely haphazard and varied valuation methods of investment portfolios managed by these lately buzzing AIFs. Along with that, the SEBI mulls for uniformity in the reporting to the performance benchmarking agencies along with an added responsibility of the investment manager to ensure the best practices. This article is an attempt to briefly understand the proposals of the said consultation paper and the implications of the same in light of the present and anticipated funds market.
Background behind the Consultation Paper
While the present legal regime does require a bunch of reportings when it comes to the valuation principles/ standards as specified in Regulation 23 of the AIF Regulation (“Regulation”), however, the present regime does not mention any guidelines with respect to these valuation principles/ standards as adopted. The present legal system does not provide for any modality to be disclosed with respect to the valuation of the AIFs investment portfolio. In such a case, the AIFs have been provided a large hand to opt for any of the valuation principles/ standards that they deem appropriate causing major distortions and differences within the market itself. This consultation paper was brought forth to address primarily this issue with a few more connecting issues on uniformity and standardisation of the practices.
Standardised approach based upon the IPEV Guidelines
The International Private Equity and Venture Capital Valuation (IPEV) Guidelines (“IPEV Guidelines”) are a bunch of recommendations that aim to streamline the practices of private capital investments and impart the best and standardised practices of investment across the globe. The present Consultation Paper presses for the use of IPEV Guidelines in order to instill uniformity and flexibility in the disclosure and practices of AIFs when it comes to the valuation of their investment portfolios. This leaf seems to have been taken from the books of other jurisdictions like Russia, China, and Canada that have accepted the IPEV Guidelines with open arms and brought changes in their laws to bring consistency with the guidelines. The proposal is therefore an attempt to impart global competitiveness and integrity in the Indian AIF industry.
This regulatory proposal is an important step in bringing transparency in the practices adopted in determining the ‘Fair Value’ of the investments categorically in unlisted startups, credit and infrastructure arenas. The standardisation of the valuation practices will facilitate a more informed track of the investment’s progress during the fund’s life and also determine an accurate investment value in case of liquidation of a fund. This is a silver lining, especially in the case of an AIF where, unlike the mutual funds industry, the valuation of portfolio entities is done half yearly or yearly, the data for which is not so easily available to the fund managers. This is where the fund managers may exploit the void in order to either inflate or deflate the valuations for mischievous purposes. Needless to mention that such a void is sufficient to cause another “2008 Financial crisis.” A uniform and standardised valuation approach will try to fill this void by allowing the investors to beware of their valuation throughout the life of a fund. This standardized approach, furthermore, is not a novel attempt in an unknown spot. Apropos the earlier Circular, this proposal is another feat in SEBI’s aim of uniformity in valuation principles across all the funds/intermediaries.
Valuation by an Independent Valuer
The consultation paper proposes that the managers of AIF should ensure the appointment of an Independent Valuer who has the required qualifications including valuer registration with IBBI, CA/CS/CMA/ or a CMA, 3 years or more experience in the valuation of unlisted securities and one who is not an associate of manager/sponsor/trustee of the AIF. This is an important step in imbibing independence in the valuation process given the fact that at present, even the associates of the manager/ sponsor/ trustee of the AIF can be the valuer (such also being the case presently in one of the AIFs).[1] Furthermore, the calculation of NAV, Category III AIFs are required to do the valuation of their investment in unlisted securities by an independent valuer ensuring independence in the total valuation process.
Standardised timeline for reporting to performance benchmarking agencies
The present practices show that the reporting about the audited data as on March 31 of the AIF (which is usually submitted around November-December) to the performance benchmarking agencies is often undermined owing to the conflict in dates of submission with the reportings done for the unaudited data as on September 30 (which is usually submitted around January-February). In order to avoid this conflict, the consultation paper proposes that the managers of AIFs ensure stipulation of a timeline for providing audited accounts of the investee company to the Fund in order to submit the report of audited data within the prescribed time of 6 months from the financial year-end. Additionally, to ensure that accurate data is submitted by AIF to the performance benchmarking agencies, the consultation paper proposes that the valuation determined upon the investee company’s audited data is submitted post the audit of the books of accounts of the AIF.
Responsibility of Manager for the Best Practices
Presently, the Managers have not been cast with any responsibility with regard to the fair valuation of the investment portfolio of the AIF. The present consultation paper proposes that Managers be made responsible for fair valuation of the investments by the independent valuer within the stipulated guidelines. It also allows managers to allow a reasonable mind to deviate from the established practices in case they do not yield a fair valuation; though, such deviations warrant an explanation too with appropriate disclosure. These deviations, if cross the threshold of 20% between two continuous valuations or 33% in a financial year, will be required to be informed to the investors with a reasonable explanation to the same. Furthermore, the managers are required to disclose information pertaining to the valuation method, accounting policy, and changes with their impacts, if any, on them.
Though such a responsibility pushing of the managers is commendable when it comes to the reporting, the free hand given to the manager in terms of determining the valuation policy and its deviation should, however, not be used to interfere with the independence of the independent valuer: the equilibrium between power and responsibility should be maintained.
Concluding Remarks
With the Indian AIF industry taking off to make a global mark, the SEBI’s recent consultation paper is a commendable step in ensuring uniform and standardised global valuation practices. With IPEV Guidelines in place, the Valuation process will not only be uniform but also be free from, if not completely, then to a great extent, from the mischievous activities of Funds for inflating the valuations. Further, the consultation paper’s proposal for prescribing criteria for an independent valuer is acceptable given the fact that the present system fails to maintain an independent room between the AIF and the valuer. The paper’s proposal with regards to casting responsibility onto the manager with regard to the valuation is an important step in ensuring an active role of the manager in facilitating the best practices in the valuation process. However, to what extent this responsibility is matched with the corollary powers bestowed upon the manager is something that needs to be taken note of. Therefore, in such a case, where the AIF industry of India is thriving at an unprecedented speed, this consultation paper is a cherry on top to ensure uniformity and global competitiveness in the AIF market.
[1] Annexure A, Consultation Paper on standardised approach to valuation of investment portfolio of Alternative Investment Funds January 7, 2023 [SEBI] available at https://taxguru.in/sebi/valuation-investment-portfolio-alternative-investment-funds.html
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Authors: Parv Pancholi (3rd Year student at National Law University Odisha), and Ishita Khandelwal (3rd Year student at National Law University Odisha)
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