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Overview Of The Recent Regulatory Changes Concerning Alternative Investment Funds In India

Pritika Kumar & Bambi Bhalla
15 Dec 2021 7:40 AM GMT
Overview Of The Recent Regulatory Changes Concerning Alternative Investment Funds In India
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The Securities Exchange Board of India (hereinafter referred to as "SEBI") has recently amended the Alternative Investment Funds Regulations, 2012 (hereinafter referred to as the "AIF Regulations") to inter alia, require filings for placement memorandums with SEBI to be done through a SEBI registered merchant banker effective November 11, 2021. Further, vide its circular dated October...

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The Securities Exchange Board of India (hereinafter referred to as "SEBI") has recently amended the Alternative Investment Funds Regulations, 2012 (hereinafter referred to as the "AIF Regulations") to inter alia, require filings for placement memorandums with SEBI to be done through a SEBI registered merchant banker effective November 11, 2021. Further, vide its circular dated October 21, 2021 ("Circular"), SEBI has issued the modalities for such filings including the obligations of the merchant bankers to independently conduct and submit a due diligence report certifying the status of the AIF's regulatory compliances with SEBI regulations. The modalities shall be applicable at the time of registration of an AIF, floating a new scheme under an existing AIF and in case of any changes to the placement memorandum. Thus, a high degree of responsibility has been placed on merchant bankers through the recent amendments, thereby adding a crucial step to the existing framework of the AIF Regulations. Additionally, SEBI vide its notification effective December 9, 2021 (hereinafter referred to as the "Notification") has further amended the AIF Regulations to introduce the definition of "co-investment" and allow co-investment by fund managers, sponsor and co-investors in an investee company by way of portfolio management. This article briefly summarizes these new amendments.

Merchant Banker's Duties:

Regulation 12 of the AIF Regulations has been amended to inter alia, include an obligation on the merchant banker to file the placement memorandum with SEBI. Further, SEBI may communicate its comments, if any, to the merchant banker prior to the launch of scheme and the merchant banker shall ensure that the comments are incorporated in the placement memorandum prior to the launch of the scheme. As per the Circular, the merchant bankers are required to independently conduct a due diligence of all information and disclosures in the placement memorandum and satisfy itself as to the veracity and adequacy of the disclosures and provide a due diligence certificate in respect of the same. A format for such due diligence certificate has been annexed to the Circular wherein the merchant banker upon examination of the placement memorandum and supporting documents submitted by the AIF/proposed AIF is required to confirm the following:

  • The veracity and adequacy of the information and disclosures made after exercising due diligence;
  • That the AIF, its sponsor and manager are fit and proper based on the criteria given in Schedule II of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008 and that none of such persons have been debarred from functioning by any regulatory authority;
  • That all material disclosures in respect of fund raising, investment by the scheme and management have been made in the placement memorandum based on latest available information;
  • That the proposed activities of the scheme are bona fide and fall within the objectives specified the AIF's articles of association/trust deed/partnership deed;
  • That the disclosures made are true, fair and necessary to enable the investors to make an informed decision with respect to the investment in the proposed scheme and are in accordance with the requirements of the AIF Regulations and other applicable requirements; and
  • That the sponsor or manager is capable to fulfil the requirement of maintaining continuing interest in the scheme as per AIF Regulations.

In addition to the above, the Circular provides a checklist of items to be confirmed by the merchant banker along with submitting the due diligence certificate. Some of the key items to be confirmed by the merchant banker are given below:

  • Whether it is provided in the placement memorandum that the terms of the contribution/subscription agreement are in line with the terms of the placement memorandum.
  • Whether the scheme intends to invest in units of AIFs. If yes, the merchant banker is required to confirm whether necessary disclosures have been made in line with SEBI's circular dated June 25, 2021 with respect to such investment.
  • Whether it is disclosed that delegation/outsourcing of any activity of the AIF to a third party will be in compliance with SEBI circular dated December 15, 2011 (Guidelines on Outsourcing of Activities by Intermediaries).
  • Whether it is disclosed that that the investment manager will establish a written conflict management policy and the timelines for adopting the same.
  • Whether the distribution waterfall illustrations have been provided for the different scenarios as specified by SEBI and if yes, whether it has been verified that the illustrations are accurate and complete.

The Circular clarifies that the merchant banker shall not be an associate of AIF, its sponsor, manager or trustee.

Co-investment under the AIF Regulations:

Regulation 2(1)(fa) of the AIF Regulations defines 'co-investment' as investment made by a manager or sponsor or investor of Category I and II AIF's in investee companies where such Category I or Category II AIF's make investment. Co-investment shall be through a co-investment portfolio manager as specified under the SEBI (Portfolio Managers) Regulations, 2020. Thus, fund managers who wish to facilitate co-investment are required to register themselves as co-investment portfolio managers. Regulation 15(1)(b) further specifies certain conditions applicable to such co-investment:

  • The terms of co-investment in an investee company by a manager or sponsor or co-investor, shall not be more favourable than the terms of investment of the AIF;
  • Provided that the term of exit from the co-investment in an investee company including the timing of exit shall be identical to the term applicable to the exit of the AIF.
  • The above proviso is applicable only for co-investment's made from the effective date of the Notification.

Further, as per Regulation 20(15) of the AIF Regulations, the manager shall not provide advisory services to any investor other than the clients of the co-investment portfolio manager as specified in the SEBI (Portfolio Managers) Regulations, 2020, for investment in securities of investee companies where the AIF managed by it makes investment. Thus, by way of the above amendments, the term 'co-investment' which was earlier not defined has now been inserted into the AIF Regulations and the scope of co-investment has been widened to include a co-investor under its ambit.

Although the regulations pertaining to AIF's have been formulated only recently, SEBI has been proactively introducing several amendments in the recent years. AIF's are evidently gaining momentum with about 800 AIF's registered in India presently. There's no doubt that AIF's make for a lucrative investment and the recent amendments are an attempt to give more structure and clarity to the regulations surrounding the same in India while keeping in mind the steady and immense growth seen overall in the AIF industry in India. A perusal of the data relating to activities of AIF's published by SEBI shows continuous growth in increase in AIF investments in India. It has also become clear vide SEBI's recent order dated January 7, 2020 against HBJ Capital Services Private Limited that the AIF Regulations extend to both unincorporated and incorporated entities carrying on alternative investment fund activities. Any contravention of the AIF Regulations is subject to high penalties including imprisonment under the SEBI Act, 1992. Thus, there is no doubt that SEBI is taking strict measures in ensuring the efficacy of investor protection measures in India. The recent regulatory changes in the AIF regime are paving the way for building a robust framework in order to effectively address the needs of the capital markets in the coming years.


Pritika Kumar is the Founder & Sentinel Counsel of Cornellia Chambers and Bambi Bhalla is Emissary Counsel – Cornellia Chambers. Views are personal.

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