By Gaurav Shanker & Ishan Jhingran
The Securities Exchange Board of India (SEBI) has introduced regulations from time to time for protection of investor rights. The objective of the SEBI Alternative Investment Funds Regulation, 2012 (AIF Regulations), effective 21-5-2012, [after repealing the SEBI Venture Capital Funds Regulation, 1996 (VCF Regulation)] is to bring all funds established or to be established in India under one omnibus statutory regime.
Scope and applicability
The ambit of AIF Regulations is far reaching as it covers under it, any fund established in India, for pooling money from investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors. The fund in question may be established in the form of a trust or a company or a limited liability partnership (LLP) or a body corporate. The AIF Regulations exempt the following from its applicability: (i) mutual funds (ii) ESOP and other employee welfare trusts (iii) family trusts (iv) collective investment schemes (v) special purpose vehicles (vi) funds managed by securitization or reconstruction companies, as these would be regulated by their respective extant regulations/rules.
It is pertinent to note that the existing funds which were governed by the VCF Regulations would continue to be governed by the same; however, once a fund intends to launch a new scheme or increase its targeted corpus, it would require registration as per the AIF Regulations. Such funds have an option of re-registering under the AIF regime, with approval from their investors (two-thirds majority). All other unregistered funds would need registration under the AIF Regulations with SEBI within six months from the date of notification of these regulations. In special; cases the fund in question can apply to the SEBI for extension up to twelve months.
Categories of AIFs
The AIF Regulations have classified the funds under its applicability into three broad groups:
- Category I – This category includes venture capital funds, SME funds, social venture funds, infrastructure funds or such other funds which have a positive spillover effects on economy.
- Category II – Funds that do not fall under category I or category III are included in this category. Also included are such funds which do not undertake leverage or borrowing other than to meet day-to-day operational requirements and as permitted under the AIF Regulations.
- Category III – Hedge funds or other funds which trade with a view to make short term returns and for which no specific incentives or concessions are given by the government or any other regulator belong to the third category.
Pertinent conditions for AIFs
All AIFs shall be required to state their investment strategy and purpose in the memorandum submitted to investors. As per the regulations, all AIFs shall have a minimum corpus of Rs. 20 crores. Further, each investor has a minimum limit of Rs. 1 crore to be met for investment into the AIF units. SEBI has capped the number of investors for a scheme of every AIF to one thousand investors. It is pertinent to note that the AIF Regulations provide for an exemption mechanism, whereby an existing fund which is unable to meet the requisite conditions can apply to the SEBI for exemption from strict compliance with the AIF Regulations. A cumulative reading indicates that the intent of SEBI is to regulate all AIFs in contrast to its erstwhile view towards regulation of funds.
Categories I and II AIFs shall be close-ended and have a minimum tenure of three years, whereas category III AIFs can be either close or open-ended. The term of AIFs can be extended by a period of two years subject to prior approval of the investors.
SEBI has permitted the listing of all close-ended units of AIFs on stock exchanges which shall be subject to a minimum tradable lot of Rs. 1 crore. AIFs may invest in securities issued by companies outside India, subject to conditions. Further, categories I and II AIFs shall not invest more than 25% of the corpus in one investee-company on the other and category III AIFs may not invest more than 10% in one investee-company. Other compliance requirements include filing an information memorandum 30 days before launching a new scheme submission of annual books of accounts to SEBI and specific conditions stipulated for each category of AIFs. The new regime requires detailed filings and compliances for an effective regulatory control over all funds established and operating in India.
In its Board meeting on 16 August 2012, SEBI has also approved regulations for investment advisors, to be notified as the SEBI (Investment Advisors) Regulation, 2012 (Advisors Regulations), the Advisors Regulations, (like the AIF Regulations) has far reaching consequences as it requires all individuals, body corporate and partnership firms engaged in the business of providing investment advice to investors for consideration to be registered and consequently regulated by the SEBI. Thus, unless specifically excluded by the Advisors Regulations, an entity or an individual providing investment advice would be under the SEBI scanner in addition to the existing regulatory regimes that might govern such investment advisory business. Investment advice not given for consideration or given via media to the public at large is not covered by the Advisors Regulations. It is further proposed that the banks may be permitted to offer investment advisory services only through a subsidiary or a Separately Identifiable Department or Division (SIDD). Such SIDD or a subsidiary would be distinct and require specific approval from the RBI.
The responsibilities of the advisors have been specifically enumerated in the Advisors Regulations such as following a code of conduct, maintaining of capital adequacy ratios, client confidentiality, ensure that the investment advice is suitable and appropriate to the risk profile of the client, conducting yearly audit, etc. The prescribed regulatory requirements present an extensive compliance regime which the potential advisors would have to adhere to.
The AIF regime coupled with the Advisors Regulations is a bold step by SEBI towards mature/futuristic regulation of the Indian financial markets. The corpus requirements, minimum investment limits for AIF’s may be difficult to small size funds/investors; on the other hand a sense of over regulation is felt with the Advisors Regulations coming into the picture, as private entities such as investment advisors were never under the ambit of such governmental control. These regulations entail immense (potential) practical implications on the Indian financial sector, encompassing specific regulation of the majority of entities involved therein. The actual market impact in terms of investment numbers and entities in this field remains to be seen, some consolidation for the smaller funds to remain viable and compliant is expected.
[The first author is a Principal Associate and the second author is an Associate, Corporate Practice, Lakshmikumaran & Sridharan, New Delhi]