Introduction
The Securities and Exchange Board of India (“SEBI”) released five consultation papers on proposed changes in regulatory norms for alternative investment funds (“AIFs”), inviting comments from the public, on February 03, 2023. These consultation papers indicate the next generation of regulatory reforms that SEBI has planned for AIFs.
An overview of the SEBI proposals is provided below.
SEBI Proposals
- Replacing the five years’ experience criteria with certification requirement[1]: Under the current regime, Regulation 4 (g) of SEBI AIF Regulations requires five (5) years of “adequate experience” of managing pools of assets or wealth or portfolio management by at least one key managerial person. This is proposed to be replaced with the requirement of obtaining relevant certification from an institution notified by SEBI, for the key investment team as well as the compliance officer of the Manager of the AIF.
The removal of the experience criteria would help first-time fund Managers. Further, certification requirements for professionals are present in the SEBI (Investment Advisers) Regulations (“IA Regulations”), wherein a registered investment adviser is required to have certain qualifications and relevant certification on financial planning or fund or asset or portfolio management or investment advisory services from NISM or other similar organisation. However, if the SEBI plans to replicate the certification requirements as currently mentioned under the IA Regulations, procurement and periodic renewal of such certification may be burdensome.
Considering the above, we would recommend SEBI to retain (in the regulations) flexibility of experience to fulfil the eligibility requirements basis the current five years’ experience criteria or vide such certification as may be prescribed by SEBI. - Investor consent for buying/ selling investments from/ to associates of AIFs and related schemes[2]: Under the current regime, an AIF needs to take the approval of 75% of its investors (by value of their investments) when it is making investments in associates[3] or units of the AIFs managed or sponsored by its Manager, Sponsor or associates of its Manager or Sponsor. To broaden the scope of transactions with “associates”, and to include buying from associates, SEBI has proposed that the 75% consent of the investors (by value of their investments) shall also be required for the AIFs to buy or sell investments from or to its associates, or schemes of AIFs managed or sponsored by its Manager, Sponsor or their associates.
This is in sync with the sentiment of the AIF Regulations and will ensure that the Regulations are more comprehensive in identifying and addressing the conflict of interests in an efficient manner. - Dematerialisation of units of AIFs[4]: Out of the 1000+ AIFs that are registered with SEBI, only a handful of them have dematerialised their units in accordance with the procedure set out by the CDSL and NSDL. SEBI has proposed that dematerialisation of units of AIFs should be made compulsory; and that by April 01, 2024, all schemes of AIFs with corpus exceeding INR 500 crore shall compulsorily dematerialise their units.
Considering that transfer of units under closed-ended funds is subject to prior approval and compliances as enlisted by the Manager, the Manager of such AIFs will have to coordinate with the relevant depository during the transfer, to ensure that the terms of the PPM and other fund documents are complied with, by the investors. - Direct plan for schemes of AIFs and trail model for distribution commission in AIFs[5]: By way of the consultation paper, SEBI has addressed the issue of double payment and mis-selling which may arise when investors invest in AIFs through placement agents/ distributors/ other intermediaries. Two proposals have been made by SEBI, as follows:
(a) AIFs will be required to offer the option of direct plan to investors, where no distribution/ placement fee will be charged. Investors who come in through direct plan will be provided with higher number of units. Therefore, all investors would continue to see the same Net Asset Value (NAV) on their unit holdings. Further, AIFs must ensure that any investor who approaches the AIF through an intermediary (such as an investment adviser or a portfolio manager), which is charging the investor a fee, invests via the direct plan route only.
(b) Investors may be charged a placement fee/ distribution fee on trail basis in case of all AIFs. However, in case of category I and II AIFs, certain higher amount of placement/ distribution fee (viz: one third of the present value of the total distribution fee) may be paid upfront to the distributor in the first year.
While these proposals seem fair from an investor viewpoint, they might impact distributors in terms of their incentives/ payments from the Managers of AIFs. However, in the longer run, this reform is expected to benefit fund Managers and the investor community. - Option to set up a liquidation scheme for unliquidated assets[6]: SEBI has proposed that at the end of the tenure of a scheme beyond two years and at the end of the extended tenure of large value funds, the Manager may close the existing scheme and transfer the unliquidated investments to a new scheme, subject to obtaining consent of 75% of investors (by value of their investments), provided that the Manager must arrange bids for a minimum of 25% of the unliquidated investments to provide exits to the investors who do not wish to continue in the new scheme, offering them a pro-rata exit.
If the minimum 25% bid is obtained from related parties of the AIF/Manager/Sponsor or from other existing investors, the same should be transparently disclosed to all investors. Such bids can only be used to provide pro-rata exit to other remaining investors. In case such fresh bids for a minimum of 25% of unliquidated investments cannot be arranged, the closing valuation of the scheme will be based on the liquidation value as determined under IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016[7], or other applicable IBC norms. In either case, the unliquidated investments will be transferred to a new scheme at the closing price (either established by evidencing minimum 25% bids, or at liquidation value) of the original scheme.
In case of setting up the new fund, fresh investors will be explicitly informed that the new scheme holds unliquidated investments from a previously closed scheme and the reasons thereof. If such new scheme has been launched with the objective to only transfer unliquidated investments from the old scheme, and not to make any new investment, then such scheme shall be exempted from certain provisions of the AIF Regulations, i.e., minimum scheme corpus, minimum capital commitment requirement, fixed tenure and investment concentration norms.
In case the consent of 75% of investors (by value of their investments) is not received either for in-specie distribution or for transfer to a new scheme per the terms proposed above, the Manager shall have to mandatorily liquidate the investments at liquidation value within a year of expiry.
While the option of setting up a liquidation/ roll-over scheme may provide respite to AIFs nearing the end of their term, certain other issues around raising funds in the liquidation scheme from fresh investors to provide an exit to the prior scheme (especially considering that investors of the prior scheme need not exit, and may become investors of the liquidation scheme) would need to be considered once the fine print of the regulatory amendment is available. Further, procuring consent of 75% of investors by value for transferring assets to a liquidation scheme may also be a hurdle in implementing this solution for unliquidated assets.
Considering that VCFs set up under the erstwhile SEBI VCF Regulations are presently nearing the end of their term, it may be useful to include such VCFs under the ambit of SEBI’s proposal with the liquidation scheme being set up under the AIF regime.
Conclusion
The proposals made by SEBI in the abovementioned consultation papers are a ‘mixed bag’. Particularly, proposals for replacement of experience criteria with a certification requirement and transfer of unliquidated assets to a liquidation scheme need to be looked into minutely and thereafter finalised post industry feedback. We would encourage fund managers to provide their inputs to SEBI before the proposals under the consultation papers are incorporated into SEBI regulations.
[1] SEBI | Consultation paper on review of eligibility criteria for the key investment team and prescribing qualification for compliance officer of Manager of an Alternative Investment Fund
[2] SEBI | Consultation paper on Investor consent for buying/selling investments from/to associates of AIFs
[3] The meaning of ‘associates’ would be interpreted as per its definition in the AIF Regulations: “associate” means a company or a limited liability partnership or a body corporate in which a director or trustee or partner or Sponsor or Manager of the Alternative Investment Fund or a director or partner of the Manager or Sponsor holds, either individually or collectively, more than fifteen percent of its paid-up equity share capital or partnership interest, as the case may be.
[4] SEBI | Consultation paper on dematerialisation of units of AIFs
[5] SEBI | Consultation paper on direct plan for schemes of Alternative Investment Funds (AIFs) and trail model for distribution commission in AIFs
[6] SEBI | Consultation Paper on providing option to Alternative Investment Funds and their investors to carry forward unliquidated investments of a scheme upon completion of its tenure
[7] The IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016 provides for ascertainment of liquidation value by two registered valuers in accordance with internationally accepted valuation standards, after physical verification of the inventory and fixed assets.
