Answer ... A private placement memorandum (PPMs) must include comprehensive information on the alternative investment fund (AIF). This includes crucial details such as:

• the background of the key investment team of the manager;
• the identified target investors;
• the specified tenure of the AIF or scheme;
• the outlined investment strategy; and
• the employed risk management tools.

The Securities and Exchange Board of India (SEBI) (Alternative Investment Funds) Regulations, 2012 (‘AIF Regulations’) do not impose legislative requirements concerning the disclosure of information by AIFs related to environmental, social and governance (ESG) factors. Nevertheless, funds have the flexibility to incorporate ESG considerations as an investment strategy, leveraging them to attract capital from investors that align with such principles.

In contrast, the International Financial Services Centres Authority (IFSCA) (Fund Management) Regulations, 2022 (‘FM Regulations’) establish an ESG framework for fund management entities (FMEs). FMEs managing assets exceeding $3 billion must:

• comply with sustainability-related requirements; and
• establish pertinent policies on governance and sustainability.

The AIF Regulations stipulate various disclosure requirements that AIFs must fulfil periodically. These encompass:

• financial, risk management, operational, portfolio and transactional information; and
• details about regulatory inquiries or legal actions in any jurisdiction.

Additionally, AIFs categorised as either Category I or Category II must annually furnish financial specifics of their portfolio companies and information concerning significant risks and corresponding mitigation strategies. For Category III AIFs, these reports must be submitted on a quarterly basis within 60 days of the quarter’s end. SEBI retains the authority to request any necessary clarification or information from the investment manager, with compliance expected within the specified timeframe.

Please see the disclosures mandated for AIFs in the PPM, detailed in question 5.2, for specific information.

Answer ... Know-your-customer (KYC) requirements: As per the SEBI Circular of 21 July 2016, coupled with Rule 9(l)(1) of the Prevention of Money Laundering (Maintenance of Records) Amendment Rules, 2015, SEBI-registered intermediaries must conduct the initial KYC process for their clients. This involves in-person verification and the timely uploading of investor/client data to both the Central KYC Records Registry and the KYC Registration Agency systems within 10 days of establishing an account-based relationship with an investor/client.

During the application stage, AIF managers are frequently required by SEBI to disclose the shareholding/partnership interest of the manager entity. Any change of control within the manager/sponsor necessitates notification and approval processes, involving both investors and SEBI.

Reporting requirements: AIFs must submit reports to SEBI on a quarterly and annual basis. Managers must also furnish information and reports to SEBI, as requested periodically, within the stipulated deadlines. Category III AIFs specifically must submit quarterly reports on the leverage undertaken.

In addition to regulatory reporting, AIFs must deliver annual reports to investors, encompassing financial information and pertinent risks. Notably, investors often include contractual provisions requiring managers to furnish additional information regarding the fund and its portfolio entities.

Additionally, the manager must generate a compliance test report and promptly submit it to the relevant entities based on the AIF’s structure. In the case of an AIF established as a trust, the report must be submitted to both the trustee and the sponsor. For other AIF structures, the CTR is to be submitted directly to the sponsor.

New reporting guidelines: The AIF Regulations and the SEBI Master Circular for AIFs of 31 July 2023 mandate the submission of quarterly reports by AIFs to SEBI. These reports play a crucial role in the monitoring and regulation of AIFs’ activities.

In a collaborative effort with industry associations such as the Indian Venture and Alternate Capital Association and Equalifi, SEBI has introduced a revised reporting format. This initiative aims to standardise the compliance standards and simplify reporting processes for AIFs.

Answer ... The AIF Regulations establish a comprehensive organisational framework to ensure the effective governance of AIFs. This framework defines the roles, responsibilities and liabilities of key entities, including the sponsor, manager, trustee and, where applicable, the decision-making investment committee. The AIF Regulations institute a fiduciary duty for AIF managers and sponsors, emphasising the prioritisation of investor interests. Mandated disclosure of conflicts of interest to investors is a key requirement, with AIF managers responsible for implementing policies to identify, monitor and mitigate such conflicts. The signing and recording of the PPM are central processes to fund management, involving comprehensive review, approval and subsequent signatures by relevant stakeholders including trustees and sponsors.

The key entities for ensuring good governance include the following:

• The trustee assumes the overarching role in administering the AIF (structured as a trust). Serving as the legal owner of the trust, the trustee plays a pivotal role in the fund’s governance. The trustee, in turn, engages an investment manager and effectively transfers its authorities outlined in the indenture through a formal investment management agreement.
• The investment manager oversees asset allocation, portfolio diversification and market analysis for informed investment decision making, optimising the AIF’s performance. Additionally, the investment manager engages third-party service providers such as auditors, custodians, merchant bankers, accountants and administrators for efficient fund management.
• The sponsor is obliged to make a sponsor commitment to the AIF, underscoring a genuine ‘skin-in-the-game’ approach. In adherence to the AIF Regulations, the sponsor is expressly barred from fulfilling its commitment by waiving management fees. This prohibition safeguards the integrity of the sponsor’s financial contribution to the fund.
• Custodians play a vital role in independently monitoring AIF investments and ensuring their secure safekeeping. Category I and II AIFs with a corpus under INR 5 billion are exempt from the requirement to appoint a custodian registered with SEBI, provided they are not involved in transactions related to credit default swaps.
• The compliance officer is mandated to ensure strict adherence to the AIF Regulations. It is incumbent upon him or her to promptly and independently report any observed non-compliance. This reporting must be executed within a stipulated timeframe of seven working days from the date of detection of the compliance deviation.
• Legal advisers ensure regulatory compliance by staying updated on evolving frameworks and guiding AIFs through the registration process. They provide counsel on fund structuring, investment agreements and risk mitigation, drafting comprehensive legal documents and conducting due diligence on potential investments.
• Tax advisers play a crucial role in guiding fund managers in optimising tax efficiency by offering insights into the tax implications of various structures, jurisdictions and investment strategies. They assist with:
• • compliance with tax laws and reporting requirements; and
  • adaptation to changes in tax codes.

In the pursuit of robust governance practices, a series of initiatives have been implemented, including the following:

• Disclosure and reporting requirements: The AIF Regulations stipulate essential disclosure obligations for AIFs in relation to investors, covering financial, risk management, operational, portfolio and transactional details. These include a requirement to report on regulatory inquiries, legal actions and material liabilities as they arise during the AIF’s tenure. Category I and II AIFs must annually furnish financial specifics of portfolio companies and material risks, with Category III AIFs providing quarterly reports within 60 days of quarter-end. Additionally, SEBI has the authority to seek clarifications or information from the investment manager, ensuring timely and transparent compliance.
• Valuation: SEBI recently amended the AIF Regulations to require the valuation of AIF securities to adhere to either:
• • the SEBI (Mutual Fund) Regulations, 1996; or
  • valuation guidelines sanctioned by any AIF industry association.
• The valuation process must be conducted by an independent valuer that meets SEBI standards. The investment manager is responsible for ensuring the accurate and unbiased valuation of the AIF’s portfolio, enhancing transparency and regulatory compliance.
• Execution of the contributory agreement: The contributory agreement provides a clear and legally binding framework for contributions, outlining the rights, obligations and responsibilities of investors and fund managers. By promoting transparency, mitigating risks and facilitating efficient operational processes, the contribution agreement not only safeguards investor interests but also contributes to regulatory compliance and overall confidence in the AIF, supporting a foundation of sound governance practices.
• Issuance of drawdown notices: This serves as a transparent communication tool, keeping stakeholders informed about the fund’s capital requirements and aligning with principles of accountability. Subject to predefined conditions, the drawdown notice ensures consistency and fairness in fund operations, contributing to effective risk management.
• Fund audit: The fund audit, conducted regularly, ensures financial transparency, accuracy and compliance with regulatory standards. This process not only verifies the fund’s financial health but also safeguards investor interests by detecting and addressing any discrepancies.
• Fund accounting: Adhering to stringent fund accounting requirements necessitates a structured system for recording and reporting financial transactions. This not only supports the audit process but also aids in providing timely, accurate and accessible financial information to stakeholders.

Answer ... The AIF must establish and maintain a robust risk management process, coupled with suitable internal controls, to ensure effective governance and mitigate potential risks. According to the AIF Regulations, AIFs must furnish information to SEBI as needed for systemic risk assessment, which encompasses the identification, analysis and mitigation of systemic risks.

SEBI is empowered to request information from an AIF at any juncture:

• concerning its activities as an AIF; or
• for the evaluation of systemic risk or the prevention of fraud.

The AIF must furnish annual reports to investors within 180 days of the year-end. These reports should encompass the following information about material risks and their management:

• concentration risk at the fund level;
• foreign exchange risk at the fund level;
• leverage risk at both fund and investee company levels;
• realisation risk (ie, change in exit environment) at both fund and investee company levels;
• strategy risk (ie, change in or divergence from business strategy) at the investee company level;
• reputation risk at the investee company level; and
• extra-financial risks, encompassing environmental, social and governance risks at both fund and investee company levels.

Furthermore, specific risk management requirements are imposed on Category III AIFs utilising leverage. These include establishing a comprehensive risk management framework with an independent risk management function appropriate to the fund’s size, complexity and risk profile. These AIFs are also mandated to maintain an independent compliance function appropriate to these factors, ensuring robust operations, infrastructure, adequate resources and effective checks and balances.

According to the FM Regulations, an FME must establish a robust risk management framework tailored to the complexity and risk profile of the scheme.