25 June, 2012
After much hullaballoo, the Securities and Exchange Board of India (“SEBI”) released on May 21, 2012, the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”) to regulate activities of collective investment funds including venture capital funds, private equity funds, hedge funds, etc. The AIF Regulations have repealed the Securities and Exchange Board of India (Venture Capital Fund) Regulations, 1996 (“VCF Regulations”).
The salient features of the AIF Regulations are discussed below:
1. Definition: The definition of ‘alternative investment funds’ (“AIF”) is very wide and includes within its ambit, any privately pooled investment vehicle which invests funds in accordance with a defined investment policy. Venture capital funds ("VCF"), hedge funds, infrastructure funds, private equity funds, small and medium enterprise (“SME”) funds, social venture fund, etc. will therefore be considered as AIFs and regulated by the AIF Regulations.
However, funds covered under any of SEBI's extant regulations, such as mutual funds, fall outside the purview of the AIF Regulations. The AIF Regulations also exclude certain other funds, such as, family trusts set up for benefit of ‘relatives’, employee welfare trusts or gratuity trust, ESOP trusts, holding company, etc.
2. Mandatory Registration: All new funds qualifying as AIFs, cannot act as such, without registering with the SEBI under the AIF Regulations. All existing unregistered funds qualifying as AIFs have to mandatorily seek registration under the AIF Regulations within six (6) months of coming into force of the AIF Regulations failing which they shall cease to carry on their activities as an AIF.
3. Treatment of Existing SEBI registered VCFs: The AIF Regulations permit the existing VCFs registered under the VCF Regulations to continue without registration till the existing VCF or scheme managed by the VCF is wound up. Such VCFs are proscribed from launching any new scheme after notification of the AIF Regulations or from increasing their targeted corpus (whether of the fund or the scheme). However, such VCFs are permitted to seek re-registration under the AIF Regulations subject to approval of two-third of their investors (by value of their investment).
4. AIF Categories: AIFs are registered under the following categories, predominantly on the basis of their investment objectives:
(a) “Category I – AIF” which invest in start-up or early stage ventures or SMEs, infrastructure or other sectors or areas which the Government or other regulators consider as socially or economically desirable. Such AIFs must be close ended (with a minimum tenure of three years) and include VCFs, SME funds, social venture funds and infrastructure funds and any other funds generally perceived to have positive spillover effects on economy and for which the SEBI or the Government or other regulators might consider providing incentives or concessions. All the foregoing funds are treated as separate sub-categories for registration purposes.
Additionally, all such funds formed as trusts or companies are construed as ‘venture capital company’ or ‘venture capital fund’ (under Section 10(23FB) of the Income Tax Act, 1961). They are, therefore, eligible for “pass through” benefits with respect to their income subject to the provisions of the Income Tax Act, 1961;
(b) “Category II – AIFs” which do not fall under Category I and III and which do not undertake leverage or borrowing other than to meet day-to-day operational requirements. Such AIFs must be close ended and include private equity funds or debt funds which are not eligible for any specific incentives or concessions; and
(c) “Category III – AIFs” which employ diverse or complex trading strategies and leverage including through investment in listed or unlisted derivatives. Such AIFs may be open or close ended, and include hedge funds or funds which trade with a view to make short term returns or such other funds which are not eligible for specific incentives or concessions are included in this category.
AIFs cannot change their category subsequent to registration, except with the prior approval of SEBI.
5. Investment Strategy: AIFs are required to state their investment strategy in their placement memorandum. Any material alteration to the strategy requires the consent of atleast two-thirds of unit holders (by value of their investment).
6. Source of Funds: Funds may be raised by way of issue of units to any investor, whether Indian, foreign or non-resident Indians.
7. Minimum Corpus of Scheme: Each scheme of an AIF must have minimum corpus of INR 20 crores.
8. Minimum Investor Ticket Size: Investment of minimum value of INR 1 crore (and INR 25 lacs in case the investor is an employee or director of the AIF or its ‘manager’).
9. Maximum Number of Investors. Each scheme of the AIF can have a maximum of one thousand investors.
10. Sponsor/Manager Commitment: Managers or sponsors are required to have a continuing minimum investment of INR 5 crores or 2.5% of the corpus of the AIF; and INR 10 crore or 5% of the corpus in case of Category III AIFs; whichever is lower and such investment cannot be through a waiver of management fees.
11. Investment Conditions:
(a) AIF may invest in securities of companies incorporated outside India subject to existing Reserve Bank of India and SEBI guidelines.
(b) Managers or sponsors are proscribed from investing in investee companies on terms more favourable than those offered to the AIF.
(c) Category I and II AIFs cannot invest more than 25%, and Category III AIFs cannot invest more than 10%, of their corpus, in one investee company.
(d) Investment by AIFs in associates (as defined under the AIF Regulations) is not permitted except with the approval of 75% of the investors of the AIF (by value of their investment).
(e) Un-invested portion of the corpus is permitted to be invested in liquid mutual funds or bank deposits or other liquid assets of higher quality such as Treasury bills, Collateralized Borrowing & Lending Obligations, Commercial Papers, Certificates of Deposits, etc., till deployment of funds as per the investment objective.
In addition to laying down broad Category specific investment conditions, the AIF Regulations also lay down additional investment norms for sub-categories under Category I AIFs, viz., VCFs, SME funds, social venture funds, and infrastructure funds.
12. Disclosures: The AIF Regulations seek to protect investor interest through mandatory transparency and disclosure norms with respect to the AIF manager, targeted investors, investment strategy, risk management tools and parameters, fees and other expenses proposed to be charged, conflict of interests, etc.
The AIF Regulations herald a new era in conduct of fund activities in India. Hitherto unregulated funds need to gear up to meet stringent investment conditions and norms. Investors in AIFs may look forward to greater protection of their investment and transparency. However, only time will tell the overall impact of the AIF Regulations on the alternative investment market in India.