On February 3, 2023, the Securities Board of India (“SEBI”) released four consultation papers, proposing various changes to be made to the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”). These changes aim to make AIFs more investor friendly, curb mis-selling of AIFs and resolve some practical difficulties faced by AIFs.
The issues outlined and the proposals laid down by SEBI in such consultation papers are given below. Public comments on these proposals may be sent to SEBI by February 18, 2023.
S. No. |
Subject matter |
Existing provisions of AIF Regulations |
Present Status/Issue faced by investors |
SEBI proposal |
|
Dematerialisation of units of AIFs |
Units issued by AIFs are ‘securities’ as defined under the Securities Contracts (Regulation) Act, 1956. The Central Depository Services (India) Limited (CDSL) and National Securities Depository Limited (NSDL) have laid down procedures for dematerialisation of units of AIFs.
|
It is observed that units of most of the AIFs are not dematerialised and are held in physical form, since AIFs prefer to issue units in physical form.
Holding of units of AIFs in a dematerialised form would bring numerous benefits to all stakeholders such as ease of monitoring for investors and ease of transfer and transmission of AIF units. |
a. Dematerialisation of units of AIFs shall be mandatory. b. As part of the first phase of this mandate, by April 1, 2024, all schemes of AIFs with corpus of more than INR 500 crores, shall compulsorily dematerialise their units. c. The terms of transfer of units of AIFs held by an investor shall continue to be governed by the terms of the private placement memorandum (PPM), agreements between the investor and the AIF and other fund documents. |
|
Direct plan to be offered by AIF |
AIFs may currently offer a ‘direct plan’ for investors in their Private Placement Memorandum (PPM) at their option. Such a direct plan would not entail any distribution or placement fees for the investor.
Further, AIF Regulations do not place any restrictions on how much of any distribution commission or placement fee can be paid on an upfront basis to intermediaries.
|
Investors investing in an AIF through an Investment Adviser or Portfolio Manager are prone to be charged twice, once in the form of Investment Adviser’s advisory fee or Portfolio Manager’s portfolio management fee, and separately via the AIF distribution fee. |
a. AIFs to be mandated to offer the option of a direct plan for investors, entailing no distribution/ placement fee. b. AIFs shall have to ensure that any investor approaching an AIF through an intermediary, that is separately charging the investor a fee (such as advisory or portfolio management fee), invests in the AIF via the direct plan route only. c. Investors on-boarded via the direct plan has to be provided an adjusted higher number of units, taking into account the lower distribution charges applicable to them versus other investors, such that all investors would continue to see the same Net Asset value (NAV) on their unit holdings. |
|
Trail model of distribution commission in AIF |
To reduce mis-selling, SEBI (Mutual Funds) Regulations,1996 and SEBI (Portfolio Managers) Regulations, 2020 mandate that Asset Management Companies and Portfolio Managers should adopt a full trail model of commission to their distributors. However, there are no regulatory guidelines in place with respect to commission/distribution fees in case of AIFs. |
Industry feedback suggests that at least in some cases, the quantum of upfront commissions for AIF distribution has gone up to around 4%-5% of the committed amount. Such high upfront commissions, particularly in sharp contrast to the trail commissions for other products, increases the chances of mis-selling of AIF schemes. |
In case of Category III AIFs, investors may be charged placement fee/ distribution fee on a trail basis. In case of Category I AIFs and Category II AIFs, investors may also be charged on a trail basis. However, a certain higher amount of placement/ distribution fee (viz one-third of the present value of the total distribution fee) may be paid upfront in the first year |
|
Treatment of unliquidated investments upon completion of a scheme’s tenure |
Presently, AIFs/Managers have the following options upon expiry of the tenure of a scheme of AIF:
a. AIFs can extend the tenure of a scheme up to two years, subject to approval of two-thirds of the investors by value of their investment in the AIF. b. AIFs/Managers have the option to distribute the assets of the AIF in-specie, after obtaining approval of at least 75% of the investors by value of their investment in the AIF. c. In case neither of the aforementioned investors’ consent is received, or if the two-year extension of the AIF is complete without investor approval for in-specie distribution of residual assets, the AIF shall fully liquidate the scheme within one year following expiration of the fund tenure. d. Large Value Funds for Accredited Investors (‘LVF’) are permitted to extend the tenure beyond two years, subject to terms of the contribution agreement, other fund documents and such conditions as may be specified by SEBI from time to time. In case the requisite conditions specified in the placement memorandum, contribution agreement or other fund documents of LVF for extension of tenure beyond two years are not fulfilled, the LVF shall fully liquidate in accordance with AIF Regulations. |
SEBI has, in the recent past, received requests/ intimation from a few AIFs regarding extension of the tenure of their schemes citing reasons such as lack of liquidity, legal/regulatory impediments, etc.
Sample data collected by SEBI for expiry of the tenure of schemes of AIFs suggests that the two-year extension period for 24 schemes of AIFs with a valuation of INR 3,037crores will expire in FY 2023-24. Further, the tenure of another 43 schemes with a valuation of Rs 13,450 crores will expire in FY 2024-25. |
At the end of the tenure of a scheme which has a term exceeding two years, and at the end of extended tenure of LVFs, the AIF/manager may close the existing scheme and transfer the unliquidated investments to a new scheme, subject to obtaining consent of 75% of investors by value, provided that: a. The AIF/manager must arrange bids for a minimum of 25% of the unliquidated investments to provide exits to the investors who do not wish to continue in the new scheme. The AIF/manager shall offer pro-rata exit to all participating investors who choose to redeem their units through this option. b. The value at which the aforementioned exit is proposed to be provided to such investors, along with the valuation carried out by two independent valuation agencies, shall be disclosed to all investors. c. If the minimum 25% bid is obtained from related parties of the AIF/manager/ sponsor or from other existing investors, the same should be transparently disclosed to all investors. Such bids can only be used to provide pro-rata exit to other remaining investors. d. In case such fresh bids for a minimum of 25% of unliquidated investments cannot be arranged, the closing valuation of the scheme will be based on the liquidation value as determined under IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, or other applicable IBC norms. e. Performance of the fund managers shall be computed in accordance with the value at which investors are provided exit or liquidation value, as the case may be. f. In setting up the new fund, fresh investors will be explicitly informed that the new scheme holds unliquidated investments from a previously closed scheme and the reasons thereof. g. If such new scheme has been launched with the objective to only transfer unliquidated investments from old scheme, and not to make any new investment, then such scheme shall be exempted from certain provisions of AIF Regulations, such as minimum scheme corpus requirement, minimum investment requirement from investor and requirement of fixed tenure.
In case the consent of 75% of investors by value is not received either for in-specie distribution or for transfer to a new scheme in accordance with the terms proposed above, the AIF/manager shall mandatorily liquidate the investments at liquidation value within a year of expiry. The manager and trustee shall be responsible for compliance with the aforesaid procedure.
|
|
Buying/selling investments to /from “associates” of AIF |
AIFs, in their normal course of business, may deal with their “associates” for various purposes including investing in associates, buying/selling of securities to/from associates, availing services of associates etc.
With respect to dealing with associates, the following norms have been specified under AIF Regulations:
a. AIF shall not invest, except with the approval of 75% of investors by value of their investment in the AIF, in (a) associates; or (b) units of AIFs managed or sponsored by its Manager, Sponsor or associates of its Manager or Sponsor. b. Special Situation Funds and Angel funds shall not invest in associates. c. Managers and Sponsors of AIFs shall abide by high level principles on avoidance of conflicts of interest with associated persons, as may be specified by SEBI from time to time. d. Any fees charged to the AIF or any investee company by an associate of the Manager or Sponsor shall be disclosed periodically to the investors. |
Similar to investment in associates, buying or selling of securities from/to associates and schemes of AIFs managed/sponsored by the same manager/sponsor or their associates may also have conflict of interest issues. |
An AIF shall not buy or sell investments, except with the approval of 75% of investors by value of their investment in the AIF, from or to a) associates; or b) schemes of AIFs managed or sponsored by its Manager, Sponsor or their associates. |
SEBI Consultation paper on dematerialisation of units of AIFs, dated February 3, 2023 can be accessed here.
SEBI Consultation paper on direct plan for schemes of AIFs and trail model for distribution commission in AIFs, dated February 3, 2023 can be accessed here.
SEBI Consultation Paper on providing option to AIFs and their investors to carry forward unliquidated investments of a scheme upon completion of its tenure, dated February 3, 2023 can be accessed here.
SEBI Consultation paper on investor consent for buying/selling investments from/to associates of AIFs, dated February 3, 2023 can be accessed here.
This update has been contributed by Vinod Joseph (Partner) and Smriti Tripathi (Senior Associate).
Argus Knowledge Centre is now on WhatsApp! Send us a message on +91 8433523504 to receive updates from our Knowledge Centre.
Express Building
9 – 10 Bahadur Shah Zafar Marg
Delhi – 110002
+91 11 23701284/5/7
155, ESC House, 2nd floor,
Okhla Industrial Estate, Phase 3,
New Delhi – 110020
The rules of the Bar Council of India do not permit advocates to solicit work or advertise in any manner. This website has been created only for informational purposes and is not intended to constitute solicitation, invitation, advertisement or inducement of any sort whatsoever from us or any of our members to solicit any work in any manner. By clicking on 'Agree' below, you acknowledge and confirm the following:
a) there has been no solicitation, invitation, advertisement or inducement of any sort whatsoever from us or any of our members to solicit any work through this website;
b) you are desirous of obtaining further information about us on your own accord and for your use;
c) no information or material provided on this website is to be construed as a legal opinion and use of this website will not create any lawyer-client relationship;
d) while reasonable care has been taken in ensuring the accuracy of the contents of the website, Argus Partners shall not be responsible for the results of any actions taken on the basis of information provided in this website or for any error or omission in the website; and
e) in cases where the user has any legal issues, the user must seek independent legal advice.