Securities and Exchange Board of India (“SEBI”) has been making continuous efforts to increase transparency among the investors and the Alternative Investment Funds (“AIFs”) so as to ensure that the hard-earned money of the investors is not being misused by the AIFs and also aids in the conscious decision making by the AIFs. To change its efforts into reality, SEBI had released six consultation papers at the start of this year inviting public comments on the changes proposed to be carried out in the SEBI (Alternate Investment Funds) Regulations, 2012 (“AIF Regulations”). Based on the above-mentioned consultation papers, SEBI vide notification dated 15th June, 2023 introduced SEBI (Alternate Investment Funds) (Second Amendment) Regulations, 2023 (“Amendment Regulations”) through which SEBI intended to bring radical changes in the AIF sector.
A. A Brand-New Fund!
With the intention of acting as a backstop facility for the purchasing of corporate debt securities in times of stress and enhancing liquidity in the secondary market, SEBI has decided to set up a new type of fund with an initial corpus of under Chapter III-C of the AIF Regulations, being the Corporate Debt Market Development Fund. With the insertion of this Chapter, it has become evident that the regulator is seeking changes in line with the mutual fund industry.
Here are a few salient features of the fund:
· It shall be constituted in the form of trust and a trustee shall be appointed.
· It shall be a close ended fund with a tenure of 15 years from the date of its first closing.
· The units of the fund shall only be offered to the Asset Management Companies and the specified debt-oriented schemes of mutual funds. However, units of such fund shall not be listed on any recognized stock exchange.
· The Manager or Sponsor shall have a continuing interest in the fund of not less than INR 5 Crores in the form of investment in the fund.
· The fund shall only buy corporate debt securities from specified debt orientated schemes of mutual funds.
· The portfolio of the fund shall be disclosed to unitholders on a fortnightly basis whereas the net asset value shall be disclosed on a daily basis.
· Appointment of a governance committee.
B. Carry Forward of Unliquidated Funds
While the regulatory framework thus far permitted investors to receive the underlying investments/ securities of the fund in in-specie distribution at the any time, including at the time of liquidation of the AIF scheme, the regulator has now taken the distribution a step further by providing for a liquidation scheme.
In the recent throes of economic frauds with the likes of Amrapali, Supratech and IL&FS, it became apparent that the funds with a limited life which are required to be wound-up in a timely manner are unable to provide returns to their investors due to the illiquid investments which are not in a position of being transferred (either due to protracted pending litigations or investigative orders, ongoing insolvency resolution or other extraneous factors). In such cases, the investors stand to lose their hard-earned savings as liquidation is imperative and realization of value is deferred for a bouquet of the underlying investments.
In order to allow the investors to have the option of realizing value from the said investments, it has now been proposed in an unprecedented move that unliquidated investments to a new scheme i.e. Liquidation Scheme. An AIF may launch a close ended scheme (post obtaining consent of 75% of investors) only for the purpose of liquidating the unliquidated investments purchased from its scheme, whose tenure has expired (“Liquidation Scheme”). The Liquidation Scheme shall neither accept any fresh commitment from any of its investors nor make any new investments.
C. Investor Consent for Investment in Associates
While the AIFs have been given flexibility to deal with their associates for transactions in the business, however, they are subject to conflict of interest. At present, in case where the AIFs are dealing with its associate, the AIF Regulations provide for mandatory investor consent and disclosure of fees being paid to such associate of AIF in exchange for services provided by associate. Over time, SEBI realized that conflict of interest may arise in other situations as well apart from the dealings with an associate. Hence, an advancement has been formulated to the existing regulations and now the AIFs are mandated to take approval of 75% of investors by their investment value in the AIF from:
i) associates; or
ii) schemes of AIFs managed or sponsored by its Manager, Sponsor or their associates; or
iii) an investor who has committed to invest atleast 50% of the corpus of the scheme of AIF, provided that such investor shall be excluded from the voting process.
This move is likely to be applauded by the investors as not only it will enhance the governance but will also bring transparency to investors for all the transactions and dealings with the related parties and will also reduce conflict of interest during the buying or selling of investments.
D. Dematerialize Units, Not Only Shares
SEBI observed that issuing and holding units of an AIF in dematerialized form will bring numerous benefits to all stakeholders, including managers, investors and regulators like ease of transparency for investors, ease of administration and monitoring for managers, ease of transfer and transmission of AIF units, etc.
While the intent and the effort of the regulator is applaud-worthy, in the final amendments which have been brought into force, the regulator has prescribed that the schemes of AIF with corpus equal to or more than Rs. 500 crores shall dematerialize the issued units by October 31, 2023, whereas all schemes of AIF with corpus of less than Rs. 500 Crores have been given an extended deadline until April 30, 2024. It appears rather counter indicative to grant less time to larger schemes with more stakeholders involved to complete the process earlier than those with less stakeholders, however, the long-term gain of this amendment is undoubted.
E. An Alteration to the Eligibility Criteria
SEBI noted that the AIF Regulations were unfair and acted as a barrier to new age and first-generation managers, who may not have adequate experience as required under the AIF Regulations. The AIF Regulations mandated that one of the key personnel shall have an experience of not less than five years in advising or managing pools of capital or in fund or asset or wealth or portfolio management or in the business of buying, selling and dealing of securities or other financial assets.
In order to facilitate skill-based approvals and to ensure objectivity in ascertaining eligibility, the regulator has replaced the above-mentioned experience requirement with a certification requirement. However, an inadvertent outcome of this amendment is that managers who have been managing funds for a long time may have to sit for examination to obtain the certificate. Managers are gripped by the fear, as failure to clear the examination might put their reputation among the peers at risk.
F. A Uniform Method of Valuation
The regulator in its consultation paper had shed light on the absence of any uniform guidelines for valuation of the investment portfolio of an AIF. This has led to absolute flexibility for the managers to adopt any principle/ methodology of their own choice for valuation of investment portfolio of the AIFs managed by them. The AIF has been mandated to carry out valuation of their investment portfolio in the manner and according to the framework as may be specified by SEBI. The Manager shall appoint an independent valuer who satisfies the criteria as may be specified by the Board from time to time and the Manager shall be responsible for true and fair valuation of the investments made by the scheme of the AIF.
Conclusion
By way of Amendment Regulations, a significant step has been taken towards digitization, strengthening corporate governance, enhancing transparency to the investors with respect to their investment in AIFs and increase accountability of the Managers. Introduction of the concept of Liquidation Scheme has provided an additional option to the AIFs with respect to the unliquidated investments at the end of tenure of a scheme. The Corporate Debt Market Development Fund has been introduced by SEBI to facilitate purchase of investment grade corporate debt securities during market instability and to instil confidence amongst the participants in the Corporate Bond Market.