[By Riva Khan]
The author is a student of Hidayatullah National Law University.
INTRODUCTION
SEBI has unveiled its proposed regulatory reforms for Alternative Investment Funds (AIFs) in India through five consultation papers released on February 3, 2023. Seeking public feedback, these papers outline the next level of reforms SEBI is planning for AIFs. The proposed changes include enhanced regulatory norms that aim to improve investor protection and promote the growth of the AIF industry in India.
If the proposals outlined in the consultation papers are adopted, they have the potential to trigger a significant transformation in the AIF industry, particularly in terms of improving transparency and facilitating greater transferability for investors.
AN ANALYSIS OF THE SAME IS GIVEN BELOW
- Currently, according to Regulation 4(g) of SEBI AIF Regulations, at least one key managerial person of a Manager of the AIF must have “adequate experience” in managing pools of assets or wealth or portfolio management for a period of five years. However, it is being proposed that this requirement be substituted with the condition that the key investment team and the compliance officer of the Manager of the AIF must acquire relevant certification from an institution that has been notified by SEBI.
The proposed alteration, which aims to replace the current prerequisite of possessing five years of experience with a certification requirement, is intended to ensure that the vital managerial personnel of an Alternative Investment Fund (AIF) possess the requisite knowledge and skills to efficiently handle the assets of the AIF.
As per the proposed modification, the vital investment team and the compliance officer of the Alternative Investment Fund (AIF)’s manager would be mandated to obtain appropriate certification from an institution that has been notified by SEBI. This certification would indicate that the individuals have undergone training and have acquired the necessary knowledge and skills to manage the assets of the AIF.
The advantage of this proposed change is that it would create a level playing field for all AIF managers. Currently, the requirement of five years of experience can act as a barrier to entry for new players in the market. However, with the certification requirement, new players can also enter the market, provided they meet the certification criteria.
Additionally, the certification requirement would ensure that the key managerial personnel of an AIF have a standardized level of knowledge and skills, which would enhance the overall professionalism and credibility of the industry.
However, there could be some concerns with this proposed change. For instance, some investors might prefer experienced managers over certified managers. Moreover, the certification process might not adequately capture the practical knowledge and experience required to manage an AIF’s assets effectively.
- At present, an Alternative Investment Fund (AIF) is required to seek the agreement of 75% of its investors (based on the value of their investments) prior to making any investments in the associates or units of AIFs managed or sponsored by its Manager, Sponsor, or their associates. However, SEBI has proposed to expand this requirement to cover the buying and selling of investments from or to associates, including schemes of AIFs managed or sponsored by the Manager, Sponsor, or their associates. In other words, the AIF must also seek the approval of 75% of its investors (by the value of their investments) for such transactions.
The reform claims that the suggested changes to the AIF Regulations are consistent with the Regulations’ spirit and will enhance their scope in identifying and dealing with conflicts of interest in a more efficient manner. However, without further context or specific details, it is difficult to evaluate the extent to which these changes will achieve their intended goals. Additionally, it is crucial to assess whether the proposed amendments address the most significant conflicts of interest issues in the AIF industry and whether they are enforceable and practical to implement.
- Despite the registration of more than 1000 Alternative Investment Funds (AIFs) with SEBI, only a handful have adhered to the stipulated procedure established by CDSL and NSDL for the dematerialization of their units. To ensure compliance across the board, SEBI has suggested that all AIFs should be required to dematerialise their units. By April 01, 2024, it will be mandatory for all AIF schemes with a corpus of more than INR 500 crore to dematerialise their units.
At present, despite the registration of more than 1000 Alternative Investment Funds (AIFs) with SEBI, only a small number have fulfilled the procedure for the dematerialization of their units as per the protocols established by CDSL and NSDL. To ensure consistency and conformity, SEBI is proposing to make the dematerialization of AIF units obligatory. Starting from April 01, 2024, it will be mandatory for all Alternative Investment Fund (AIF) schemes that have a fund size exceeding INR 500 crore to convert their units into dematerialized form.
- SEBI has identified potential issues with double payment and mis-selling in AIF investments made through intermediaries such as placement agents or distributors. To address these concerns, SEBI has proposed two solutions:
(a) A new requirement has been put in place for Alternative Investment Funds (AIFs) to provide investors with the option of a direct plan that does not involve any distribution or placement fees. This direct plan will offer investors a higher number of units compared to other investment plans. It is required that all investors, irrespective of their investment mode, receive an equivalent Net Asset Value (NAV) for their units. Furthermore, Alternative Investment Funds (AIFs) are accountable for directing investors who use intermediaries that levy fees towards the direct plan.
(b) All Alternative Investment Funds (AIFs) are permitted to levy a placement or distribution fee on investors on a recurring basis. Nonetheless, for Category I and II AIFs, intermediaries may be paid an upfront amount of a greater proportion of the total distribution fee (equal to one-third of the present value) in the initial year.
SEBI has proposed two measures to tackle the issue of mis-selling and double payment that may occur when investors invest in Alternative Investment Funds (AIFs) through intermediaries. The first proposal requires Alternative Investment Funds (AIFs) to offer investors a direct plan option that does not involve any distribution or placement fees. Investors who opt for the direct plan will be allocated a larger number of units, while all investors will receive the same Net Asset Value (NAV) for their holdings. It is the responsibility of the Alternative Investment Funds (AIFs) to make certain that investors who utilize intermediaries that impose fees are steered towards the direct plan.
The second proposal permits AIFs to charge investors a trial placement or distribution fee. In the case of Category I and II AIFs, intermediaries may receive an upfront placement or distribution fee equivalent to one-third of the total fee’s present value in the first year.
- SEBI has suggested a plan for managers of investment schemes to handle unliquidated assets. In cases where the scheme tenure exceeds two years or the extended tenure of large value funds, the manager may close the existing scheme and transfer the unliquidated investments to a new scheme. However, this can only be done with the consent of 75% of investors (by value of their investments). In order to ensure equitable treatment of investors, the manager of the scheme is obligated to arrange for bids on at least 25% of the unliquidated investments, which will enable investors who do not wish to continue with the new scheme to exit the investment and receive a pro-rata share.
In the event that the minimum bid for unliquidated assets cannot be obtained from unrelated parties, related parties may bid but only for the pro-rata exit of the remaining investors. However, this must be done with transparent disclosure to all investors. If arranging bids is not possible, the scheme’s closing valuation will be based on the liquidation value.
When setting up a new fund to transfer unliquidated investments, it is required to inform new investors about the reasons for the transfer. Such a fund will be exempt from certain AIF regulations if its sole purpose is to transfer these investments.
In case 75% of investors do not provide their consent for in-specie distribution or transfer to a new scheme, it becomes the responsibility of the manager to sell the investments at the liquidation value within a year from the scheme’s expiration.
SEBI’s proposal to allow for the setting up of a liquidation scheme for unliquidated assets in alternative investment funds (AIFs) is aimed at providing greater flexibility to AIF managers in managing their funds. This proposal is especially relevant in situations where AIFs are unable to liquidate their assets due to market conditions or other factors.
In its entirety, SEBI’s proposal to allow the establishment of a liquidation plan for unliquidated assets in AIFs is a good step, since it gives AIF Managers more freedom in managing their funds while also protecting investors’ interests.
CONCLUSION
Both the good and negative aspects of SEBI’s suggestions to switch from experience criteria to certification requirements and move unliquidated assets to a liquidation scheme should be carefully studied. The ideas may increase professionalism overall and safeguard customers from losses, but they may also increase prices and administrative work for investment advisers and portfolio managers. As a result, SEBI should keep in touch with industry participants and consider their opinions before making any judgements. Any adjustments implemented should ultimately find a balance between safeguarding clients and assisting India’s competitive and thriving investment advice business.