A recent Sebi concept paper proposing draft Sebi (alternative investment funds) Regulations, 2011 (proposed AIF regulations) seems to have worried the entire private equity/venture capital/investment fund industry with respect to their future business plans in India. Before highlighting the concerns, there is a need to quickly examine the key objectives behind the Sebi concept paper and the proposed AIF regulations. The first is to extend the ambit of investment management regulations, currently limited to regulating mutual funds, collective investment schemes, venture capital funds (VCFs), and portfolio managers. This is sought to be done by bringing all other fund structures and private pools of capital under the regulatory umbrella by classifying them under several sub-categories like real estate funds, PIPE funds, private equity funds, strategy funds, SME funds etc.
(depending upon the applicant?s investment objectives) and requiring them to register as AIFs. The existing VCF regulations are also proposed to be scrapped and subsumed in the proposed AIF regulations. Second, protecting HNIs and institutions from becoming victims of fraud, unfair trade practices and conflicts of interest by prescribing investment restrictions and disclosures by the fund entities in which they invest. The protection under the existing regulations is more oriented towards safeguarding retail investors as big ticket investors are assumed to be more informed and savvy.
Unfortunately, a careful look at the concept paper and proposed AIF regulations reveals that if implemented, the proposed regulations would result in a practical hardship for the PE/VC and investment management/advisory industry. There is a need to discuss some of the significant implications arising out of the proposed AIF regime, if the same is implemented in its current shape.
First, many of the PE funds, because of their multiple investment objectives, would need to register under separate categories, say, as a PIPE fund, private equity fund, venture capital fund etc. Requiring multiple registrations (by creating separate entities) is going to be a formidable task from the perspective of timelines, costs and other practical implications. Add to this the mandate not to have more than one scheme in an AIF, which will further increase the administrative burden.
Second, the above is coupled with a high degree of micromanagement. For instance, PIPE funds can invest only in shares of small-sized listed companies not on any of the market indices, venture capital funds can have maximum investments of R250 crore with restrictions of not investing in a company promoted by any of the top 500 listed companies or by their promoters, PE funds can invest only in unlisted securities, etc.
Further, it has been prescribed that PIPE funds and SME funds investing in listed securities would not be charged with insider trading on making investments in listed companies post conducting a diligence. But pursuant to such diligence and purchase, the entity shall be prohibited from dealing in securities of such an investee company for five years. Such a restriction is unreasonable and excessive. Restrictions have also been prescribed to keep the AIFs close-ended and keeping the maximum number of investors up to 1,000 with a minimum investment amount of one crore rupees for each investor. The current fund structures, with multiple closings and new investors coming at subsequent closings with fresh investments, seem to be restricted. All these may change the way investment funds work in India.
Third, a requirement has been prescribed for the sponsors/managers to contribute an amount equal to 5% of the fund size to be locked in till the last investor is paid, which may commercially not work out well. The intent seems to be towards aligning the interests of the sponsors with the fund, but a 5% limit is not feasible and needs to be toned down if not done away with. To add to the worries of such entrepreneurs, any securities remaining unliquidated at the end of the life cycle of the AIF would have to be taken up by them and there would not be an in-kind distribution, as is customary in the industry. Such requirements would certainly deter the setting up of funds.
Fourth, all the investment managers/advisors to AIFs are sought to be regulated under a separate advisors/managers regulatory regime. But by providing a very stringent set of investment restrictions, the AIF regime is already proposed to be heavily regulated. Adding a further layer of regulations for their managers/advisors, who in any event would have to act within the AIF regulatory framework, would be excessive.
Fifth, funds irrespective of their legal domicile but collecting money from Indian investors would have to register as an AIF under the relevant category.
Making an offshore fund subject to AIF regulations because of having a miniscule percentage of Indian investors notwithstanding the majority of foreign investors would be unreasonable. This aspect needs more clarity.
The concept paper and the draft regulations are a mixed recipe of several sub-regulations, all with different heads and tails, unworthy of implementation in the current proposed form. The proposed AIF regime is likely to face stiff opposition from the industry circles and the final version of the regulations is expected to be a diluted one. A regulatory desire to do something new and different should not end up harming the investment fund regime in India and, in any event, it?s not Sebi?s job to micromanage the investors.
The author is with Finsec Law Advisors
