On August 1 2011 the Securities and Exchange Board of India (Sebi) published a concept paper regarding regulation of Alternative Investment Funds (AIFs). The paper is accompanied by draft proposed regulations for AIFs, and seeks to substantiate the need to regulate and register AIFs as a distinct asset class. Accordingly, it emphasises the necessity to have a comprehensive legal framework for private pools of capital. Through the paper, Sebi has expressed its concern in relation to venture capital funds (VCFs) being used as an investment vehicle for other classes of funds and for investing in companies other than start-ups.
Sebi's move towards regulating private pools of capital was expected given the recent regulatory developments in mature markets such as the USA and Europe. What came as a surprise, however, is its sweeping ambit as to what needs to be registered, and severe restrictions which go beyond the nature of investments.
This is well exemplified by the stipulation that the manager/sponsor/designated partner must have an interest of not less than 5% of the fund, which has to be by way of positive contribution (and not through the waiver of management fees).
Further, micromanagement is evidenced by the stipulation that registration of AIFs will be under one of the nine categories: VCFs, PIPE Funds, PE Funds, Debt Funds, Real Estate Funds, Infrastructure Equity Funds, Small and Medium Size Enterprise Fund, Social Venture Funds and Strategy Funds (as a residual category). This categorisation seems to have stemmed from Sebi's intent to more than push for investments in early-stage companies, SMEs and infrastructure.
Some of the restrictions reek of socialism, if not worse. To wit: "VCF shall not invest in any company that is promoted, directly or indirectly by any of the top 500 listed companies by market capitalization or by their promoters," and "PIPE fund shall invest in shares of small sized listed companies which are not part of any market indices in exchanges having nationwide terminals" (sic).
Similar restrictions apply for PE Funds.
The concept paper goes beyond prescribing disclosure and transparency norms and tends to regulate the actual business of funds leaving no flexibility to tweak the strategy in response to changing market conditions. Constraints have also been imposed as regards tenure, target size and number of investors in the fund (not more than 1000 with each investor holding at least 0.1%).
Further, the proposed regulations seek to cover offshore funds that invest in India and not just those which have Indian investors and/or Indian fund managers.
While a move to broadly regulate AIFs cannot be faulted, the manner and approach is alarming. It needs to be remembered that the high growth trajectory of the Indian economy is severely dependant on entrepreneurial activity which in turn struggles to be funded domestically and has to fall back on foreign funds.
Prohibiting funding of successful promoters of listed companies for their new ventures is well-warped socialism to say the least. Excessive regulation of such foreign investors may well outweigh the benefits and this may have adverse effect on the availability of risk capital in the country.
One can only hope that Sebi will do a rethink as to the nature and manner of regulating AIFs. Watch this space!
Aditi Manchanda and Shuchita Bhushan