ARTICLE
28 April 2022

SEBI Amends Regulations Governing AIFs, The Post-Pandemic Safe Haven

Alternative Investment Funds ("AIF") in India are governed by the Securities and Exchange Board of India (Alternative Investment Regulations), 2012 ("AIF Regulations") and regulated by the Securities and Exchange Board of India ("SEBI").
India Finance and Banking
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Alternative Investment Funds ("AIF") in India are governed by the Securities and Exchange Board of India (Alternative Investment Regulations), 2012 ("AIF Regulations") and regulated by the Securities and Exchange Board of India ("SEBI"). AIFs are investment funds that are established or incorporated in India that are privately pooled from foreign or Indian sources, in the form of trusts, companies, bodies corporate and limited liability partnerships. Funds collected by AIFs are invested in accordance with a defined investment policy for the benefit of the investors. AIFs are not governed 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 SEBI formulated to regulate fund management activities1.

AIFs play a significant role in reducing the volatility that may be associated with other forms of investments as their performance is disassociated from the turbulence of the stock market. An AIF may seek to register itself in one of the three following categories:

  1. Category I: For investments in start-ups, early-stage ventures, small and medium-sized enterprises, or other projects which the Government deems to be socially and economically viable (e.g. venture capital funds, infrastructure funds, angel funds and social venture funds, etc.);
  1. Category II: For investments which do not fulfil the criteria for Category I or Category III, and which do not undertake leverage or borrowing for purposes other than meeting day-to-day operational requirements (i.e. investments in equity and debt securities for which no specific incentives or concessions are provided by the Government, including private equity funds, debt funds, etc.); and
  1. Category III: For investments aimed at generating short-term returns achieved by employing diverse or complex trading strategies (e.g. hedge funds, private investments in public equity funds, etc.)2.

The AIF Regulations were amended the SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2022, effective March 16, 20223. By way of this amendment, Regulation 15(1)(d) of the AIF Regulations was altered. Regulation 15(1)(d) laid down the conditions that AIFs under Category III would be subject to for investments in listed equity.

Position Prior to the Amendment

A. Investments by Category III AIFs were not permitted to exceed 10% of the:

(i) Net asset value in listed equity of any company, special purpose vehicle or limited liability partnership or body corporate the AIF was making an investment in("Investee Company")4; and

(ii) Corpus of the scheme of the AIF (net of expenditure for administration and management of the fund estimated for the duration of the scheme from the day of its launch to the last day of the specified term) ("Investable Funds")5 in securities other than listed equity of an Investee Company-directly or through investment in units of other AIFs.

B. Investments by the large value funds for accredited investors of Category III AIFs were not permitted to exceed 20% of the:

(i) Net asset value in listed equity of an Investee Company; and

(ii) Investable Funds in securities other than listed equity of an investee company, directly or through investment in units of other AIFs.

Position After the Amendment

A. Investments by Category III AIFs are now disallowed from investing more than 10% of the:

(i) Investible Funds or the net asset value of the scheme, as calculated by the fund managers (for investments in the listed equity of an Investee Company); and

(ii) Investable Funds in an Investee Company, directly or through investment in units of other AIFs.

B. Investments by the large value funds for accredited investors of Category III AIFs are now disallowed from exceeding 20% of the:

(i) Investable Funds or the net asset value of the scheme, subject to the conditions specified by the SEBI from time to time; and

(ii) Investable Funds in an Investee Company, directly or through investment in units of other AIFs.

The Covid-19 pandemic has caused investors to incline towards investment options which are more bolstered from the ups and downs of the stock market. This has led to alternative investments becoming more mainstream for high net-worth individuals, and entities seeking high risk-adjusted returns and diversifications from other, more traditional, asset classes. This increase in demand led the total assets of AIF, on a yearly basis to move up by 38% to Rs. 6.09 lakh crore as of December 2021 from Rs. 4.42 lakh crore in the previous year6.

Leading up to this most recent amendment to the AIF Regulations, the SEBI has continued to streamline the way AIFs function-seeking to make the route more attractive to potential investors while simultaneously ensuring that the interests of all the stakeholders remain watertight and protected.

Foot notes

1 Regulation 2(1)(b) of the AIF Regulations.

2 Regulation 3(4) of the AIF Regulations.

3 SEBI Circular No. SEBI/LAD-NRO/GN/2022/75 dated March 16, 2022.

4 Regulation 2(1)(o) of the AIF Regulations.

5 Regulation 2(1)(p) of the AIF Regulations.

6 'Assets of alternative investment funds grow 38 per cent in 2021, cross ?6 lakh crore', The Hindu Business Line, accessed at https://www.thehindubusinessline.com/data-stories/data-focus/assets-of-alternative-investment-funds-grow-38-per-cent-in-2021-cross-6-lakh-crore/article65183095.ece

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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