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
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
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
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
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