The Securities and Exchange Board of India (“SEBI”) has updated the regulatory framework applicable to AIFs/ VCFs, seeking to make portfolio investments in offshore companies vide SEBI Circular dated August 17, 2022, titled ‘Guidelines for overseas investment by Alternative Investment Funds (AIFs)/ Venture Capital Funds (VCFs)’ (“SEBI Circular”). AIFs/ VCFs are currently permitted to make portfolio investments in equity and equity linked instruments of offshore venture capital undertakings[1], subject to taking case by case approval of SEBI for each such investment. Such approval is granted by SEBI to AIFs/ VCFs on a ‘first come first serve basis’, within an overall limit of USD 1,500 million.
SEBI has formalised the application process by prescribing an application format and the necessary information, declarations and undertakings required to be submitted by the AIFs/VCFs aspiring to get SEBI approval for making offshore investments. SEBI has also taken steps to further liberalise the regime. Earlier, AIFs/ VCFs were required to invest in companies with an Indian connection, but now SEBI has removed this condition.
Updated Framework
1) Indian connection requirement done away with
Previously, AIFs/VCFs could only invest in investee companies, which had an Indian connection, like back-office operations of an offshore company being carried out in India. As a relaxation of the regime, the above condition has now been done away with. This is a welcome move by SEBI, since it will enable domestic funds to explore investments in offshore companies with overseas operations without requiring an Indian connection. This liberalisation in the regime has the potential to cater to the increasing appetite among domestic investors, including family offices and HNIs, seeking routes to make portfolio investments outside India. This newly liberalised regime will serve as an alternative to the relatively less flexible Liberalised Remittance Scheme (LRS) route for making investments.
2) Permitting Reinvestment
SEBI has initiated another positive change. It will now allow reinvestment of sale proceeds by AIFs/ VCFs to the extent of the original investment made in the said overseas investee company. Such sale proceeds (to the extent of investments) are available for all AIFs/VCFs for reinvestment, subject to the requirements of fund documents and other requirements of the SEBI regulations. This also implies that AIFs/ VCFs don’t have to take fresh SEBI approval for acquiring interest in a new portfolio entity in case of reinvestment.
Eligible Jurisdictions
Hygiene checks have been prescribed for safeguarding the interests of investors:
AIFs/ VCFs shall not invest in an overseas investee company, which is incorporated in a country identified in the public statement of Financial Action Task Force (FATF) as:
(i) A jurisdiction having strategic Anti-Money Laundering or Combating the Financing of Terrorism deficiencies to which counter measures apply; or
(ii) A jurisdiction that has not made sufficient progress in addressing the deficiencies or has not committed to an action plan developed with FATF to address the deficiencies.
The securities market regulator of the country where such investee company is incorporated must be a signatory to the IOSCO multilateral MOU or a signatory to the bilateral MOU with SEBI.
All AIFs/ VCFs shall sell or transfer investments in an overseas investee company only to entities eligible to make overseas investments, according to the Foreign Exchange Management Act, 1999.
Enhanced Regulatory Reporting
- An independent due diligence undertaking is required to be submitted by the trustee/ board of directors/ designated partners.
- AIFs/ VCFs will have to furnish divestment details of the overseas investments to SEBI in the format prescribed in Annexure B of the SEBI Circular within three working days for updating the overall limit available for overseas investment by these entities. Also, all overseas investments already sold/ divested till date, will have to be reported to SEBI within 30 days from the date of the SEBI Circular i.e. by September 16, 2022.
Takeaway
The removal of the condition for AIFs/ VCFs to invest only in overseas portfolio entities that have an Indian connection is a welcome liberalisation. The changes introduced open up new avenues for family offices, high net worth individuals and institutional investors seeking to invest in offshore portfolio entities. To that extent, the SEBI Circular provides a competitive advantage to Indian funds in the global market, facilitating growth of the Indian AIF industry.
The ability to reinvest sale proceeds (up to the amount of original investments) without another SEBI approval too is a welcome change. However, no respite has been provided to AIFs/ VCFs that may need to receive shares of another overseas entity in a swap transaction or pursuant to a merger/ amalgamation or similar corporate structuring at the portfolio level.
Lastly, despite much anticipation, the Reserve Bank of India and SEBI have not increased the currently available industry-wide limit of USD 1,500 million for AIFs/ VCFs to make overseas portfolio investments. According to media reports, such funds are near the exhaustion limit and hence an upward revision of this limit would enable domestic funds to benefit from the new SEBI regulations.
[1] As per SEBI Circular dated October 1, 2015, ‘it is clarified that “Offshore Venture Capital Undertakings” means a foreign company whose shares are not listed on any of the recognized stock exchange in India or abroad.’
