Permitting “Variable Capital Companies” at IFSC: A new avenue for Fund formation in India.

[By Muhammed Ijaz]

The author is a student of Faculty of Law, University of Delhi.

Introduction

Bearing with success stories of thriving Asset Management Industries across countries like Singapore, Hong Kong, UK and Luxembourg and their role as engines of growth at their respective entrepreneurial promoting economies, the Government of India(“Government”) has keenly emphasized in bringing slew of measures over the time to catalyze and attract the global players into the Indian asset management/Investment fund industry.

The ongoing developments and deliberations among the Government stakeholders to possibly permit the Variable Capital Companies(“VCC”), as a new vehicle for pooling of funds, in the India’s first and only International Financial Services Centre (“IFSC”), Gujarat International Finance Tec-city (‘GIFT city’), evidences the above.

Pooling Vehicles for Fund formation in India      

For the purpose of fund formation and its management, the legal regime emanating from the mandates of Securities and Exchange Board of India (‘SEBI’) applicable to  the Indian mainland and to IFSC through International Financial Services Centers Authority (‘IFSCA’), contemplates three types of corporate structures as permissible fund pooling vehicles. Namely, Trusts governed under the Indian Trusts Act, 1882, Companies governed under the Companies Act, 2013, and Limited Liability Partnerships (LLPs) under the Limited Liability Partnership Act. Of these, trusts are found to be predominantly used to pool funds for a variety of reasons, ranging from historical factors to pragmatic considerations such as lower compliance costs and more confidentiality.

Given the benefits of the trust structure, an established legal and commercial practice has developed around its formation and operation of Investment fund industry over the years in India. However, despite being the most sought-after pooling vehicle, Trust route suffers from certain limitations including: The trustee(s), being the legal owner(s) of the trust, has/have unlimited liability; The eligibility of a trust to claim tax treaty benefits in case of overseas investments is always a contentious issue.

Variable Capital Companies (“VCC”)

To address above discussed limitations which has been similarly prevalent in other jurisdictions across the globe, some jurisdictions like Singapore, Hong Kong, Ireland and UK have set up a legal regime for a fourth type of corporate structure for the Investment Fund formations. A hybrid vehicle which combines the advantages across these three structures of Trust, Company and LLP. These entities are called “Variable Capital Companies” in Singapore, “Investment Company of Variable Capital” (‘ICVC’) and “Open-ended Investment Companies” (‘OEIC’) in the UK , “Open-ended Fund Company” (‘OEFC’)in Hong Kong, and “Irish Collective Asset-management Vehicle” (‘ICAV’) in Ireland. It combines the advantages of limited liability of a company with the flexibility available in a trust structure of exit and entry without alteration to the capital structure.

Essentially, VCC is a collective investment scheme or pooling vehicle.  VCC corporate entity structure allows multiple collective investment schemes to be managed under a single corporate entity and allowing each of these to be ring-fenced. This structure is similar to multi-class fund structures such as the Protected Cell Company (‘PCC’) and Segregated Portfolio Company (‘SPC’) prevalent in other offshore fund jurisdictions such as Cayman Islands, the British Virgin Islands and Mauritius.

The participants, who are the shareholders of the VCC, invest money [or any other asset / contribution] with the objective of making a return or profit from the investment. They invest in the capital of the VCC, but do not have control over the day-to-day management of the VCC. The constitution documents of a VCC should include a Memorandum of Association setting out the main objective of the VCC and other objectives ancillary to the main objective, and an Article of Association, setting out the rules for the internal management of the VCC.

Krishnan Committee – Recommendations

In September 2020, The IFSCA, the regulator at the India’s IFSC which contemplates the need for VCCs as a fund formation vehicle set up an Expert Committee under the chairpersonship of Dr. K. P. Krishnan (“Krishnan Committee”) to examine the feasibility of the VCC in India.

In its report in May 2021, the Krishnan Committee assessed the features of a VCC or its equivalent, in other jurisdictions such as the UK, Singapore, Ireland and Luxembourg. In the background of Committee’s assessment of various jurisdictions and derived principles, The Committee recommended the introduction of VCCs in the IFSC by way of a separate law containing the substantive provisions governing the VCC structure in IFSCs for this purpose. It delineated the benefits of this structure over the traditional ones.

The Committee noted that as a hybrid structure, a VCC carries the benefits of a company, limited liability partnership and trust, while avoiding their limitations. It allows access to various treaty benefits that do not typically extend to unincorporated entities. These would make a VCC a preferred entity to house funds in IFSCs.

Additional recommendations of the Committee as follows:

  1. The share capital of the VCC should be variable in nature to allow for easy entry, redemption and buy-back of its shares by investors.
  2. A VCC can have multiple sub-funds, which are like schemes of a mutual fund. Sub-funds should not be separately incorporated. The VCC should issue a separate class of shares for each sub-fund.
  3. The assets and liabilities should be segregated at the sub-fund level. The assets of any one sub-fund should not be used to discharge the liabilities of the VCC or any of its other sub-funds.
  4.  VCCs should be allowed to issue, redeem or buy back the securities issued by them, or undertake capital reduction exercises, without restrictions.
  5. VCCs should be allowed to pay dividends out of their capital as well as profits.
  6. From a tax perspective, each sub-fund should be deemed to be a separate ‘person’ and all the provisions of Indian tax laws should apply to the sub-funds treating it as a separate person.

Proposed Legal Framework for VCCs at IFSC   

On consideration of the suggestions and recommendation to introduce VCC as an investment fund vehicle in the IFSC by way of a separate law, laid down through the Krishnan Committee report, the IFSCA in May 2022, set up an Expert Committee under the chairmanship of M.S Sahoo to draft a legal framework for allowing the VCC structure to operate in IFSCs in India (‘M.S. Sahoo Committee’).

In its report submitted on 12th October 2022, the Committee has agreed with the majority of recommendations of the Krishnan Committee’s report that VCCs should be introduced as a vehicle for investment management in IFSCs. Additionally, the report conducted a comprehensive analysis of the legislation governing VCC structures in different international jurisdictions, and examine the laws in India, and has proposed a legal framework (‘Proposed legal Framework’) within the International Financial Services Centers Authority Act, 2019 instead of the Krishnan Committee recommendation to bring a separate legal framework governing VCC in Indian Jurisdiction.

In the later part of the M.S. Sahoo Committee report, The Proposed Legal framework has also been elaborately provided, which includes Draft Legislation (Amendments to the IFSCA Act,2019), Draft Regulations relating to Variable Capital Companies (a skeletal structure of the proposed Regulations).

  1. Draft Legislation:

Vide the draft legislation named as, International Financial Services Centers Authority (Amendment) Act, 2022, the report proposed for the following amendments in the principal act, the IFSCA Act,2019.

  • Amendment to Section 3 of the IFSCA Act,2019 to insert the definitions for “VCC” and related terms such as “stand-alone VCC”; “sub fund”; “umbrella VCC”.
  • Insertion of a separate new chapter III-A titled as “Variable Capital Companies” in the IFSCA, Act 2019.
  1. ‘Draft Regulations’ relating to Variable Capital Companies:

Along with the Draft Legislations, the report also proposed a skeletal structure of a Draft subordinate legislation as Regulations, to be enacted for facilitating the Legal framework for VCCs at IFSC. The skeletal Draft Regulations spanned over 10 chapters with 122 Regulations, which includes the regulations relating to Incorporation of a VCC; Kinds of Share Capital; Voting Rights; Management, Administration and Dividends etc.

Conclusion:

Since 2015, India’s maiden IFSC in Gujarat’s GIFT City, established with an intent to serve as gateways for Indian investments as well as hubs for global investment, have been witnessing a swift adaptation of innovative financial products and services that are being widely accepted at entrepreneurially promoting economies like Singapore, UK and Luxembourg. Permitting emerging sectors including aircraft leasing, global inhouse centres, an international bullion exchange, insurtech, fintech and special purpose acquisition companies (‘SPAC’) in the India’s IFSC evidences the above. Therefore, the proposed plan to permit VCC for fund formation in IFSC comes as no surprise, that since its establishment, IFSCA has left no stone unturned in providing facilitating a thriving asset management market, yet with a relaxed regulatory environment, as evidenced above.

The availability of a thriving market for asset management services is a key source of competitive edge for any competitive financial service center market. The proposed introduction of the VCC regime is certainly reflecting the larger strategy of the Government and the IFSCA on shoring the offshore financial services, a step in the right direction to facilitate the competitiveness of India’s IFSC with that of other IFSCs in the jurisdictions like London, New York and Singapore. Not as farther as to dream, the functioning of the VCC-structure in IFSCs would also provide a template to consider the introduction of a VCC-structure for the domestic Indian financial system too at a later stage after taking into account its performance and impact over the domestic Indian economy.

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