In a move designed to tighten its
control over alternative investment funds (AIFs), the
Securities and Exchange Board of India (Sebi) drafted and
proposed a set of guidelines entitled 'Regulation of
Alternative Investment Funds' on August 2 2011. The aim was to
extend the perimeter of regulation to unregulated funds, and
ensure systemic stability, increase market efficiency and
encourage the formation of new capital through a new regulatory
regime. The Sebi approved and announced the guidelines at its
board meeting on April 2 2012.
The AIF Regulations will be applicable to all pooled
investment vehicles, except specifically notified vehicles such
as mutual funds, CIS schemes, family trusts, ESOP trusts,
employee welfare trusts or holding companies, which are already
covered under regulations by other regulators.
To increase transparency in the alternative investment
market, AIFs will now need to clearly delineate their
investment purpose to the Sebi and stick with the investment
intention at launch. Private equity, venture capital, private
investment in public equity (Pipe), infrastructure funds, real
estate funds and hedge funds will need to register under the
AIF categories listed by the Sebi.
The funds are divided into three categories. The AIFs under
Category I are funds that will have positive spillover effects
on the economy and include venture capital funds, SME funds,
social venture funds and infrastructure funds. These funds
shall be closed-ended, shall not engage in leverage and shall
follow investment restrictions as prescribed for each category.
Certain incentives or concessions might be considered by the
Funds under Category II are funds that are given no specific
incentives or concessions by the Government of India (GOI) or
any regulator. They shall not undertake leverage other than to
meet day-to-day operational requirements as permitted in the
Regulations. They include private equity funds, debt funds,
fund-of-funds and other funds not classified as Category I or
Category III. These funds shall be closed-ended, shall not
engage in leverage and have no other investment
Category III includes hedge funds that are considered to
have negative externalities such as exacerbating systemic risk
through leverage or complex trading strategies. These funds can
be open-ended or closed-ended and may engage in leverage
subject to limits specified by the Sebi. According to the Sebi,
These funds will be regulated 'through the issuance of
directions regarding areas such as operational standards,
conduct of business rules, prudential requirements,
restrictions on redemption, and conflicts of interest'.
AIF sponsors must contribute at least 2.5% of a fund's total
corpus or Rs 50 million (US$912,000), whichever is lower. An
AIF will be required to have a minimum corpus of Rs 200
million. A minimum contribution of Rs 10 million by each
investor is required, with each fund allowed up to 1,000
investors. An AIF is not allowed to invest more than 25% of its
capital into a single company.
The SEBI (Venture Capital Funds) Regulations, 1996 will be
repealed. However, existing venture capital funds will continue
to be regulated by the VCF Regulations until such funds are
wound up. And existing funds that are not registered under the
VCF Regulations and are not able to comply with all provisions
of the AIF Regulations may seek Sebi exemption from strict
compliance with the latter.
Following release of the draft guidelines in August 2011,
there were concerns among investors on the fate of existing
funds in the market. The final framework has cleared some of
these earlier concerns.
The Sebi guidelines will impose the first systematic
regulatory regime over private equity in India. While the
Sebi's goal is to better control market risk and ensure greater
accountability, some legal practitioners are worried that the
regulations might be counterproductive to the performance of
private equity. They are concerned that they might exert too
many limits on how investors organise their funds.
Shantanu Surpure, managing attorney at Mumbai boutique law
firm Sand Hill Counsel, was recently quoted in Asian
Venture Capital Journal as saying that one of the
attractions of investing in India is the range of sectors and
investment styles that can be mixed and matched to make up a
fund portfolio. "In some ways, there will be less flexibility
going forward and it's unclear whether that will affect
appetite for private equity investing," he says.
But others suggest that compliance with the new regulatory
framework should not prove to be a deterrent of any kind.
Talwar Thakore & Associates' partner Feroz Dubash says:
"There have been concerns that the new regulations might
complicate the investment process and might have an adverse
effect on investor sentiment. However, greater regulation of
alternative funds is a global trend and investors are likely to
take that into account and cope with these tightened
to return to IFLR supplements