The rise of domestic capital in alternative asset space requires the AIF Regulatory Platform be made available to In-house Funds
The Indian growth story has been propelled by alternative asset classes that witnessed an unprecedented inflow of domestic and foreign capital in the last few years. Alternative Investment Funds (“AIFs”) have played an essential role in this and have raised, as on June 30, 2022[1], a whopping INR 6,94,520 crore (Indian Rupees Six lakh ninety-four thousand and five hundred twenty crore), of which actual deployed capital stands at INR 3,11,343 crore (Indian Rupees Three lakh eleven thousand and three hundred forty-three crore). These numbers are up from INR 2,90,339 crore (Indian Rupees Two lakh ninety thousand and three hundred thirty-nine crore) of capital raised and INR 1,19,758 crore (Indian Rupees One lakh nineteen thousand and seven hundred fifty-eight crore) of actual capital deployed, as on June 30, 2019[2]. Securities and Exchange Board of India (“SEBI”), being the capital market regulator in India, has played an active role in streamlining the AIF industry. SEBI’s proactive and investor-friendly approach is often reflected in the discourses with market participants as well as in the guidelines / circulars / regulations issued for the AIF industry.
The extent of customisation and flexibility permitted under the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”) and the accessibility to professional fund management services offered in India have encouraged domestic investors to look inwards, rather than towards the more traditional and globally preferred financial centres such as Singapore, Luxemburg, or Mauritius. The role played by domestic capital from Indian LPs like corporates, family offices, and high net worth individuals (“HNIs”) in growth of alternatives investments cannot be emphasised enough. With Indian businesses growing with the country’s economic progress, allowing and facilitating in-house funds with a dedicated investment manager within the AIF regulations (“In-house Funds”) is the need of the hour.
In-house Funds have unique requirements like accepting funding from a single ultra-HNI family or group entities with an in-house investment manager focused on making investments as per the requirements of the family or group. The general expectation for AIFs has been to raise capital outside a single family or group of entities. SEBI’s concerns seem to emanate from the ‘pooling’ requirement for AIFs for which participation of external investors is considered a critical parameter. Considering that the AIF Regulations are umbrella regulations which regulate all private pools of capital (unless exempted from the purview of the AIF Regulations, like NBFCs, holding companies, employee welfare trusts, etc.), denial of the availability of the AIF platform to In-house Funds would push them into a regulatory void. Such orphaning of In-house Funds would deprive regulatory oversight to such funds which are fast emerging as a platform to channel growth of domestic capital.
It is relevant to note that specific exemptions are envisaged under AIF Regulations for excluding few structures from being treated as AIFs including family trusts set up for benefits of ‘relatives’ as defined under the Companies Act of 2013, read with rule 4 of Companies (Specification of Definitions Details) Rules, 2014. The regulatory intent seems to be to restrict such family trusts that may be pooling money and are set up for the benefit of ‘relatives’, which includes members of the Hindu Undivided Family, spouses and immediate family only, from being treated as an AIF under AIF Regulations. However, funds raising monies from extended families or group entities may not be covered by this exemption given the restrictive nature of the definition of ‘relatives’ and hence such In-house Funds will naturally fall under the purview of AIF Regulations. Many a times families wish to set up an investment fund professionally managed by a dedicated manager as a step towards building track-record before operating as multi-family office and accepting external capital. Providing regulatory parasol to such vehicles could help in nurturing and facilitating the growth of domestic capital which would eventually promote entrepreneurship. In the absence of an explicit recognition of the concept of In-house Funds within the ambit of the AIF Regulations, many family offices, HNIs and large corporates are hesitant to take up the AIF route as a means of capital deployment for achieving their investment and social objectives. This paradox exists even when AIF Regulations do not explicitly prohibit setting up such vehicles, and the natural regulation for regulating such vehicles currently seems to be AIF regulations only.
AIFs offer many advantages in terms of tapping unexplored opportunities; these help in achieving diversification goals of investors and are also being increasingly used by family offices, HNIs and body corporates for their social pursuits. Many family offices and body corporates prefer to set up or participate in highly curated AIFs with professional management for various reasons such as their strategic requirements, social pursuits or tapping underrated opportunities. GPs too find the idea to manage funds with capital from a single family or group of entities efficient compared to raising a conventional fund. The AIF platform is a natural fit for such vehicles, and it is challenging to achieve such a wide set of objectives through conventional vehicles due to operational and / or regulatory issues.
In-house Funds are globally recognised and are used typically as a part of family offices in many jurisdictions around the globe. Such jurisdictions often offer a light touch regime for such products owing to requirements of specific investors. For instance, the Monetary Authority of Singapore offers an automatic route to set up funds where the entities involved belong to the same group of corporations. A parallel can also be drawn from the recently notified fund management regulations by International Financial Services Centres Authority (“IFSCA”), which recognises the need for specific pooled products for single family office trying to achieve their investment goals without compromising the indispensable requirement for precision financial products. IFSCA allows self-managed pooled products for a single-family office.
India stands at the threshold of a major economic boom. The argument for formalising the concept of In-house Funds in India is receiving more traction than ever. The stakeholders from the AIF industry should engage with SEBI and provide ground level feedback for formal recognition of In-house Funds within the AIF regime. There is a good case for the AIF Regulations to be upgraded to enable registration of In-house Funds under a specific category through a lighter and differentiated approach.
[1]SEBI | Data relating to activities of Alternative Investment Funds (AIFs)
[2] Ibid.
