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On 21 May 2012 SEBI notified the SEBI (Alternative Investment Funds) Regulations, 2012 [the “AIF Regulations”] requiring mandatory registration of private collective investment vehicle. This comes on the back of a series of steps Sebi has been taking in this regard. In order to create distinct private pooled investment vehicles and to regulate VCFs, SME Funds, Social Venture Funds and other registered or unregistered investment vehicles under one roof, SEBI came out with the concept paper on Alternative Investment Funds Regulation on August 01, 2011 accompanied by draft regulations called SEBI (AIF) Regulations, 2011. It was observed that VCFs were being used as an omnibus investment fund which leaves most of the private investment funds dissatisfied. Hence there was a need for comprehensive regulation was felt. Registration under VCF Regulations was not mandatory in nature, hence, many unregistered funds were in existence. What are the implications of the new regulations?
All AIFs are mandatorily required to get themselves registered with SEBI as per the Regulations. Important question is which all funds are to be treated as AIFs and require registration.
Regulation 2 (1) (b) defines “Alternative Investment Fund” as:
Alternate Investment Fund means any fund established or incorporated in India in the form of a trust or a company or a limited liability partnership or a body corporate which,-
(i) is a privately pooled investment vehicle which collects funds from investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors; and
(ii) is not covered under the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, Securities and Exchange Board of India (Collective Investment Schemes) Regulations, 1999 or any other regulations of the Board to regulate fund management activities”
The following have been kept out of the purview of the definition of AIF:
• Family trusts set up for the benefit of ‘relatives’ as defined under Companies Act, 1956;
• ESOP Trusts;
• Employee welfare trusts or gratuity trusts;
• “Holding Companies” within the meaning of Section 4 of the Companies Act, 1956;
• Other special purpose vehicles not established by fund managers, including securitization trusts, regulated under a specific regulatory framework;
• Funds managed by securitisation company or reconstruction company which is registered with the Reserve Bank of India; and
• Any such pool of funds which is directly regulated by any other regulator in India.
Analysing above, what should be the constituents of a fund to be recognised as an AIF?
• An AIF can be set up as a company or LLP or trust or a body corporate model. Unincorporated bodies, which are not even allowed by RBI Act, are not allowed to raise funds.
• The fund should be a private fund engaged in pooling investments from investors.
o SEBI vide these Regulations, has made the scope of the word ‘private’ very liberal and wider.
o Regulation 10(f) restricts a maximum number of investor in AIF to 1000. Hence, a private fund shall be having a large base of investors which may go up to a thousand. Interestingly, the limit on number of investors is not for the AIF, but for a scheme of AIF.
• Another feature of AIF is that it should be pooling investments. The simple meaning of pooling is collecting money from a group of investors to invest further for a mutual benefit. So, any fund raising money privately for further investment can be treated as AIF subject to fulfillment of other conditions.
• Funds should be an investment vehicle. Funds to be passively engaged in investments in prescribed areas/companies. The essential meaning of “investment” is outlay of money with an objective of generating a rate of return, other than by carrying on a substantive activity. In other words, persons putting in money in the fund do not get management rights in investee and do not participate actively in day to day affairs of the investee.
• It should not be in nature of a mutual fund registered under SEBI (Mutual Fund) Regulations, 1996.
• It should not be registered under SEBI (Collective Investment Schemes) Regulations, 1999. The difference between a CIS covered by the CIS Regulations, and AIF Regulations will be that the former may invite public subscriptions, while the latter may only privately source their money.
• It is not regulated by any other SEBI regulations regulating fund management activities.
• Exception provided in proviso (v) carves out another important feature of the Fund. The exception applies to all SPVs not regulated by fund managers and are regulated by specific regulatory framework. In other way round, a fund managing its investments regularly i.e. a fund engaged in regular buying and selling of investments shall be treated as an AIF. Fund management, thus, becomes another essential characteristic of an AIF.
Territorial scope of the Regulations
The definition of AIFs under Regulation 2 (1) (b) starts as “any fund established or incorporated in India in the form of a trust or a company or a limited liability partnership or a body corporate …….”
Further, Regulation 2(1)(o) defines an “investee company” as:
“any company, special purpose vehicle or limited liability partnership or body corporate in which an Alternative Investment Fund makes an investment”
As a body corporate includes a company registered outside India, a careful reading of both the definitions extracted above clarifies that the scope of these Regulations extends to:
• Funds established in India and investing in India and/or abroad;
• Funds established abroad and investing in India.
Therefore, an entity registered outside India and executing business outside India is not required to get itself registered under these Regulations.
• An AIF to compulsorily obtain certificate of registration from SEBI.
• In case of an existing unregistered fund falling within the definition of AIF, the fund may continue to operate only for a period of six months from the date of these Regulations or where it has applied for registration within such period of six months, till disposal of the application.
o SEBI may extend such period of six months to twelve months in some special cases.
• Existing schemes of existing unregistered funds will be allowed to complete their agreed tenure and shall not be allowed to raise further fund other than commitments already made.
• Registered Venture Capital Funds [VCFs] continue to be regulated under VCF Regulations until the existing fund or the scheme managed by such fund is wound up.
o No new scheme to be launched by such funds after issue of the AIF Regulations.
o The existing fund not allowed to increase the targeted corpus
note here that ‘corpus’ has been defined as total amount of committed funds by the investors by way of a written contract or any such document as on a particular date. A clear provision in this regard leaves a way out and it can be interpreted that funds may be raised as per the verbal commitments even after existence of the AIF Regulations.
Registrations to be granted category wise
SEBI, after receiving comments on the draft Regulations, notified following categories of AIFs requiring registrations:
• Category I Alternative Investment Fund
o invests in sectors or areas which the government or regulators consider as socially or economically desirable and relevant for the country and have a developmental focus rather than pure business motive.
Includes venture capital funds, SME Funds, social venture funds, infrastructure funds.
• Category II Alternative Investment Fund
o which does not fall in Category I and III and which does not undertake leverage or borrowing other than to meet day-to-day operational requirements and cannot engage in derivatives investments.
Therefore, such funds are intended to do business with the corpus only and will not be borrowing funds.
• Category III Alternative Investment Fund
o Funds employing diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives. To earn higher returns by leveraging the investors’ capital these funds may like to keep the liberty of borrowing
Hedge funds, fund of fund, real estate funds are typical examples
Regulations are more stringent for this category. Necessary directions are to be issued by SEBI soon
Eligibility Conditions [Reg 4]
Different eligibility criteria for LLP, Company, Trust or a body corporate have been prescribed.
Further, the Regulations also prescribe eligibility criteria for the sponsor or manager of the AIF. The sponsor or manager is required to have a continuing interest in the AIFs of not less than two and half percent of the corpus or five crore rupees, whichever is lower, in the form of investment in the AIFs and such interest shall not be through the waiver of management fees. A continuing interest of five percent or ten crores rupees has been prescribed for Category III AIFs.
From where can an AIF pool money?
Instead of adopting a specific approach depending on the type of applicant, the Regulations have laid down blanket investment conditions whereby all categories of AIFs would be subject to certain conditions, the chief being:
• Funds may be raised, on private placement basis, from Residents, Non Residents and foreign investors
o It is important to point out here that eligible investors under FEMA Regulations include VCFs but do not include the AIFs, hence, requiring immediate amendment to this effect.
• Each scheme of the AIF shall have corpus of at least twenty crore rupees;
• Minimum investment to be accepted by an investor is one crore rupees;
o The directors and the employees of the AIFs and/or managers have been kept out of the purview of the above limit and minimum investment amount for them is twenty five lakh rupees.
How can an AIF raise funds?
Before raising any fund the AIF is required to file a placement or information memorandum, along with the prescribed fee, with SEBI at least 30 days prior to launch of the scheme giving detailed and material information about the AIF and the manager for comments of SEBI, if any. No such fee is to be paid on filing of memorandum for launch of first scheme.
The procedure of filing an information memorandum before raising funds is somewhat similar to that prescribed for companies coming out with public offers.
How long an AIF can sustain?
• Category I and Category II AIFs
o Close ended and the tenure of fund or scheme shall be determined at the time of application subject to sub-regulation (2) of this Regulation
o Schemes launched by such funds shall have a minimum tenure of three years.
o Buy-back not allowed as close-ended in nature
o Such AIFs may get themselves listed on a stock exchange after closure of the scheme
• Category III Alternative Investment Fund may be open ended or close ended.
o Close ended funds may apply for listing.
o Open ended funds can buy-back the units issued
• Extension of the close ended AIF may be permitted up to a further two years subject to approval of two-thirds of the unit holders by value of their investment
o In absence of any extension/further extension, the AIF is to fully liquidate within one year following expiration of the fund tenure or extended tenure
Where an AIF can invest?
All AIFs are to decide in advance the investment strategy for the pooled fund and same is to be mentioned in the Placement Memorandum at the time of launching a scheme. Interestingly, an AIF can invest in LLPs too as definition of an “investee company” includes an LLP.
AIFs are allowed to invest in associates subject to approval of seventy five percent of investors; further, Un-invested portion of the corpus may be invested in liquid assets of higher quality till deployment of funds as per the investment objective. Further categorywise investment conditions have been prescribed by the Regulations.
Welcomes hedge and real estate funds with open arms
The Regulations, now, permit a hedge fund, a real estate fund or a REIT to carry out business in India after registration with SEBI. Previously, REITs were not identified in India, one of the difficulties being absence of transparent tax laws. However, as LLPs can be formed as an AIF, hence business of REITs may be effectively carried out by an LLP model as taxability is only in hands of partners. In absence of pass-through status, AIFs is likely to be taxed at either corporate level, or in representative capacity – either of which may not be tax efficient. Barring taxation issues, which are, though, critical, it is now possible to have real estate funds also in operation.
The new modest and all in all Regulations posses several other features like investment strategy, disclosure of periodic information to investors, valuation procedure, audit of fund, dispute resolution, winding up of funds etc. to bring greater clarity to the market and the investors and its all-encompassing nature will bring several investment entities that were hitherto unregulated by SEBI. This constitutes a drastic change and will require investors to adapt themselves to a new and transparent regulatory regime.
This change in the regime of funds will also require amendment to exchange control laws, FDI norms and various SEBI Regulations which are yet to be notified.