Introduction
The Securities Exchange Board of India (“SEBI”) has released a consultation paper on May 23, 2024[1] (“Consultation Paper”), wherein it has suggested modifications to certain aspects of the valuation framework for AIFs.
SEBI’s proposals intend to provide relaxation on the following aspects:
- Valuation methodology as per the SEBI prescribed valuation norms;
- Change in ‘valuation methodology and approach’ being construed as ‘material change’;
- Eligibility criteria of AIF-appointed independent valuers; and
- Timeline for reporting investment portfolio valuation by AIFs to benchmarking agencies.
An overview of SEBI’s proposals is provided below:
SEBI Proposals
Enabling Valuation of Unlisted Securities as per IPEV Guidelines:
As per SEBI circular dated June 21, 2023, on Standardised approach to valuation of investment portfolio of Alternative Investment Funds (AIFs), (subsumed by SEBI master circular on AIFs dated May 07, 2024 (“Master Circular”)),[2] the valuation of securities for which valuation norms have been prescribed under SEBI (Mutual Funds) Regulations, 1996 (“MF Regulations”) shall be carried out as per the norms prescribed under the MF Regulations. The aforesaid circular effectively provides that valuation of securities which are not covered under the MF Regulations, shall be carried out as per the International Private Equity and Venture Capital Valuation Guidelines (“IPEV Guidelines”).
The Consultation Paper recognises that there are fundamental differences between mutual funds and alternative investment funds in their holding period strategy and valuing of investment portfolios.
Proposal
In response to AIF industry’s submissions, SEBI has now proposed a revision to the current framework for valuation of securities, recommending that such valuation be carried out as per valuation guidelines endorsed by eligible AIF Industry Association based on the recommendations of AIPAC (presently being the IPEV Guidelines), rather than the norms prescribed under the MF Regulations. This proposal has been made with a view to adopt a more tailored approach to valuation for such investments, considering AIFs holding private investment require a valuation based on cash flows which are pertinent to the underwriting thesis.
Secondly, SEBI has proposed that securities for which valuation norms have been prescribed under MF Regulations (other than valuation of unlisted securities, mentioned in the paragraph above), shall be carried out as per the norms of the MF Regulations. SEBI’s intention behind this proposal is to maintain consistent valuation standards across SEBI Regulations, irrespective of intermediary/fund.
Material change:
SEBI circular dated June 21, 2023, also declared any change in the methodology and approach for valuation of investments of scheme of an AIF as a material change, which significantly influences the decision of the investor to continue to be invested in the scheme of the AIF. In case of such material changes, AIFs are required to provide an exit option to its investors in according with Chapter 2 of the Master Circular.
It was submitted to SEBI that prior to the release of SEBI circular dated June 21, 2023, AIFs across were using different valuation methodologies and approach to evaluate investments by AIFs. Due to the shift in methodology and approach as directed by SEBI in the aforesaid circular, there was a lacuna regarding whether change in valuation methodology due to the regulatory mandate would amount to material change.
Further, it was also submitted by the AIF industry that modifications to the valuation methodology within the scope of the IPEV Guidelines should not be construed material change, since IPEV Guidelines are broad set of valuation methodologies/ approaches and provide flexibility to compute valuation based on one or more techniques specified therein.
Proposal
To provide clarification, and provide flexibility to AIF managers and valuers, SEBI has proposed the following:
- A change in valuation methodology/ approach to comply with Chapter 22 of the master circular on AIFs on ‘Standardised approach to valuation of investment portfolio of AIFs’, shall not be construed as a ‘Material Change’; and
- Change in the valuation methodology/ approach within the valuation guidelines/ valuation norms prescribed for AIFs shall not be considered as ‘Material Change’. However, in such instances, the approach ( both old and new) taken to evaluate the investment must be disclosed to the investors to ensure transparency.
Proposed relaxation in eligibility criteria of independent valuer:
The current AIF valuation framework requires registration with Insolvency and Bankruptcy Board of India (“IBBI”) and membership of the Institute of Chartered Accountants of India (“ICAI”) or the Institute of Company Secretaries of India (“ICSI”) or the Institute of Cost Accountants of India (“ICMAI”) or the CFA Institute, as one of the eligibility criterion for an independent valuer.
The industry sought a clarification for valuers, who are set up as an entity, whether valuers who are set up as an entity are required to be IBBI-registered valuer entity and at the same time, whether all of its members are required to have ICAI / ICSI / ICMAI / CFA Institute membership.
It is pertinent to note that the individual and partnership / company valuers have separate eligibility criteria for registering as valuers. No partnership or company can be registered as valuer if three or all the partners or directors, whichever is lower, are not registered valuers. Thus, it is possible that an IBBI-registered valuer providing valuation services to an AIF may not hold membership of ICAI / ICSI / ICMAI / CFA Institute.
Proposal
To streamline the qualification requirements for an independent valuer, SEBI has proposed to revise the current eligibility criteria for independent valuer as provided under:
- For a partnership entity or company being the independent valuer, such partnership or company shall be a valuer entity registered with IBBI; and
- The deputed / authorised person(s) of such registered valuer entity, who undertake(s) the valuation of investment portfolio of AIFs, shall have a membership of ICAI or ICSI or ICMAI or CFA institute.
Extension in timeline for reporting of valuation of investment portfolio by AIFs to performance benchmarking agencies:
Under the current regime, AIFs are required to provide audited data on cash flows and valuation of their scheme-wise investments to performance benchmarking agencies within six months from the end of the financial year.
However, the same becomes difficult for the manager to comply with, since under the Companies Act, 2013, the investee companies have a timeline of six months from the end of the Financial Year for completing their audit. It is likely that all investee companies do not adhere to the timeline due to various reasons such as on-going litigation of the investee company with the AIF, non-cooperation due to such litigation, stress situations, failed early-stage investments, etc.
Proposal
SEBI has, therefore, proposed that AIFs shall provide audited data on cash flows and valuation of their scheme-wise investments, after the audit of books of accounts, as per the AIF Regulations, to the benchmarking agencies within seven months from end of the Financial Year.
Conclusion
The release of the Consultation Paper seems to be a positive move to remove practical difficulties faced by the AIFs in discharging their regulatory obligations pertaining to valuation norms prescribed by SEBI. Stakeholders are encouraged to provide inputs to the Consultation Paper so that their suggestions get incorporated in the notified rules.
[1] https://www.sebi.gov.in/reports-and-statistics/reports/may-2024/consultation-paper-on-review-of-certain-aspects-of-the-framework-for-valuation-of-investment-portfolio-of-aifs_83552.html
[2] https://www.sebi.gov.in/legal/master-circulars/may-2024/master-circular-for-alternative-investment-funds-aifs-_83229.html
