Disposition of unliquidated assets has been a major challenge for some Alternative Investment Funds (“AIFs”). Most AIFs in the market today are close ended i.e., they have a fixed tenure, within which AIF managers are expected to fully exit the AIF’s portfolio investments. The recent data on AIFs, published by Securities Exchange Board of India (“SEBI”), indicates that AIF investments in unlisted securities are significantly higher (almost by a factor of 2.8) than that in listed securities. SEBI has increased its scrutiny of those AIFs which are seeking tenure extensions, are in the midst of their liquidation period or are struggling with expired liquidation period.
Liquidation period refers to the one-year period following the completion of an AIF’s tenure, during which the AIF manager is expected to liquidate all the fund’s unliquidated assets and distribute the proceeds to its investors. Dissolution period is a term used to define the time after the expiry of liquidation period and can be opted by AIFs to deal with unliquidated investments, with requisite investor consent.
SEBI had notified (now rescinded) the concept of liquidation schemes, which offered AIFs the flexibility to roll over the unliquidated investments in a separate AIF scheme with requisite investor consent. This provided some respite from potential regulatory breaches for AIFs nearing the end of their tenures or liquidation periods. AIF managers were also allowed to make in-kind distributions of the unliquidated assets of the AIF subject to requisite investor consents. While these options were helpful in some instances, however they proved not to be broad-based solutions for many market participants on account of potential adverse tax consequences and other Indian foreign exchange restrictions. Accordingly, SEBI shelved the “liquidation scheme” concept in April 2024 in favour of the “dissolution period”. After an extensive public consultation exercise, SEBI finally in April 2024 notified the concept of “dissolution period” and “additional liquidation period”.
SEBI has offered additional liquidation period as a one-time flexibility to only those AIFs whose liquidation period has expired on or before July 24, 2024. Such AIFs shall have an extended liquidation period until April 25, 2025.
AIFs can now avail the dissolution period with the consent of 75 per cent of the investors by value of their investment in the AIF, only during such AIF’s liquidation period. SEBI has prescribed in detail the procedure to be followed by AIF managers for opting dissolution period in relation to an AIF. This procedure mandates AIF managers to obtain bids, on a consolidated basis for all unliquidated assets of the AIF, from the market and offer proportionate exits to investors who do not wish to continue under the dissolution period.
However, if an AIF manager is not able to obtain bids from the market but is able to obtain 75 per cent consent of the investors, then the dissolution period can still be opted for such an AIF. Interestingly, AIF managers failing to obtain bids for the unliquidated assets during the liquidation period are required to report their performance to benchmarking agencies at value equivalent to INR one, regardless of finally realised value.
SEBI has also clarified that in absence of AIF managers receiving requisite consents for making in-kind distribution or opting for the dissolution period during the liquidation period of the AIF shall have the option to mandatorily distribute the unliquidated assets of the AIF in-kind to its investors. AIF managers may also write off the assets of the AIF allocable to investors that are not willing to accept in-kind distributions for any reason.
Reporting Prescribed by SEBI
SEBI has issued a Circular dated July 09, 2024, requiring certain information to be filed by AIFs availing of the additional liquidation period and / or the dissolution period.
Schemes intending to avail of the additional liquidation period are required to submit a brief report to SEBI in a prescribed format, which includes certain details of the AIF, its unliquidated portfolio and pending investor complaints in accordance with the Circular.
The Circular also requires AIFs entering into a dissolution period to file an information memorandum with SEBI before the expiry of the liquidation period or the additional liquidation period, which must also be accompanied by a due diligence certificate from a merchant banker.
Hit or Miss
The extant route for AIF managers fosters an efficient and transparent ecosystem for the AIF industry. Not only the investors have access to all information on the available bids prior to choosing between an in-kind distribution or a dissolution period, the AIF managers are also not left in limbo as they can distribute in-kind or write off the AIF investments to avoid potential regulatory breaches.
The streamlined process penalises the AIF managers for failing to liquidate an AIF’s investments within its original or extended tenure, given the mandate on performance reporting for unliquidated investments / in-kind distributions.
The investors and AIF managers will have to adapt to the new rules of the game. AIF documentation and negotiations on these terms will also have to evolve in line with the applicable regulations. The regulations and practical challenges around liquidity for investors and performance reporting of AIF managers may usher in a new era where investor / AIF manager-led secondary transactions / structures may be pre-planned well in advance.
