SEBI Proposes Changes to the AIF Regime

Posted On - 23 March, 2023 • By - Tanuj Modi

The Securities Exchange Board of India (SEBI) has, in the month of February 2023, released five consultation papers proposing changes to the Alternative Investment Funds (AIF) regime in India, particularly in relation to: (I) eligibility criteria and qualifications for key investment team and compliance officer of manager of an AIF; (II) dematerialisation of units of AIFs; (III) buying and selling of investments from / to associates of AIFs; (IV) treatment of unliquidated investments after completion of tenure of a scheme; and (V) distribution fees / commissions for intermediaries. The underlying theme of the changes proposed vide the consultation papers is to address the prevalent limitations in the current regulatory regime. Let’s take a closer look at the key proposed changes:

a)  Eligibility criteria for key investment team members and compliance officers: Under the current SEBI (Alternative Investment Funds) Regulations, 2012 (AIF Regulations), at least one key personnel of the manager of an AIF must have 5 years of adequate experience of managing pools of assets, or in wealth or portfolio management, and at least one key personnel must have the relevant prescribed professional qualification. The relevant consultation paper finds the requirement of having adequate experience to be subjective in nature and which may act as a barrier to new age managers and first time fund managers from providing services to AIFs. Accordingly, it proposes to replace the experience criteria with a requirement of obtaining a certification from an institution notified by SEBI for the key personnel. Similarly, persons to be designated as the compliance officer of the manager of an AIF are proposed to be mandated to obtain a certification from an institution as may be notified by SEBI.

b)  Dematerialisation of units: The consultation paper pertaining to dematerialisation of units, proposes that all units of an AIF must be in dematerialised form, starting with schemes of AIFs with a corpus of more than INR 5 billion being required to mandatorily dematerialize their units by 01 April 2024.

c)  Consent requirement for buying / selling investments from or to associates of an AIF: The relevant consultation paper proposes that prior approval of 75% of the investors in the AIF (by value of investment) must be obtained prior to buying or selling investments from or to any associates of an AIF, or from or to any schemes of AIFs which are managed or sponsored by the manager, sponsor of the AIF, or their associates. Under the AIF Regulations, an associate is any company, body corporate or limited liability partnership in which 15% of the equity capital or partnership interest is held by the director, trustee, partner, sponsor, or manager of an AIF, or by the director or partner of the sponsor or manager of the AIF.

d)  Option to carry forward unliquidated investments: The relevant consultation paper proposes that at the end of tenure of the scheme of an AIF, either extended or otherwise, the manager of the AIF may, subject to receiving consent of 75% of investors of the scheme, transfer any unliquidated investments of the existing scheme to a new scheme. However, the manager must arrange bids for at least 25% of the unliquidated investments to provide pro-rata exits to the investors who do not wish to continue in the new scheme.

Bids: If the minimum 25% bid of unliquidated investments is obtained from related parties of AIF / manager / sponsor or any of the existing investors, the same should be disclosed to all investors of the scheme. Further, where the bids are not arranged for a minimum of 25% of the unliquidated investments, the closing valuation of the scheme is to be determined in the manner as prescribed under the Insolvency and Bankruptcy Code, 2016.

Set-up of new scheme: The investors in the new scheme / fund must be informed that the scheme holds unliquidated investments from previously closed schemes. Further, where the new scheme is only proposed to hold unliquidated investments from an old scheme, such a scheme shall not be required to comply with the minimum corpus, minimum capital commitment, fixed tenure, and investment concentration norms as provided under the AIF Regulations.

e)  Direct plans for scheme of AIFs and introduction of trail model for distribution of commission: In order to address concerns relating to double payment of commissions, and mis-selling of AIFs through placement agents / distributors / and other intermediaries, the relevant consultation paper proposes the following changes:

Direct plan: AIFs must offer an option of a direct plan to investors where no distribution / placement fee will be levied, whereas in cases where an investor approaches the AIF through an intermediary, who is charging the investor a fee, the investment must be made mandatorily under the direct plan.

Trail model: The placement fee / distribution fee payable to intermediaries in relation to all categories of AIFs must be on a trail basis, and not on an upfront basis. However, in case of category I and category II AIFs, up to one-third of the placement fee / distribution fee may be paid upfront in the first year.

The consultation papers and the changes proposed thereunder aim to enhance the quality of governance and management of AIFs, all the time maintaining the focus on investor protection. The proposal in relation to mandatory dematerialisation of units may, however, receive negative feedback from the industry, as the same is an increased compliance requirement for an AIF as well as the investors, who may now be required to open and maintain demat accounts in India. The consultation papers also propose significant changes for providing increased flexibility for AIFs and their investors in relation to unliquidated investments after expiry of tenure of the scheme. Upon completion of the process in relation to receipt and consideration of public comments, SEBI will consider the above proposals at its board meeting, following which the same may be implemented by way of an amendment to the AIF Regulations.

Authors: Tanuj Modi

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