August 5, 2011



Alternate Investment Funds Regime in India – A Game Changer!

SEBI releases Concept Paper and Draft Regulations


In light of recently released SEBI Concept Paper and Draft Regulations, we are organizing an interactive audio call to provide our views and insights.

Speakers: Mr. Siddharth Shah and Ms. Bijal Ajinkya

Date: Tuesday, August 9, 2011

Time: 6 p.m. IST

Dial - in Details: +91 22 6629 0347 / +91 22 3065 0347

RSVP: Mr. Gaurav Bhandari (Email

The Securities and Exchange Board of India (“SEBI”) has issued the Concept Paper along with the draft SEBI (Alternative Investment Funds) Regulations, 2011 (“Draft Regulations”) that seek to introduce a comprehensive regulatory framework for regulating private pools of capital i.e. Alternate Investment Funds (“AIFs”). The Draft Regulations are open for public comments till August 30, 2011.

Currently, SEBI regulates Mutual Funds, Collective Investment Schemes (“CIS”), Venture Capital Funds (“VCF”) and Portfolio Managers. Keeping aside Mutual Funds and CIS, which are more retail in nature, the only option available to an investment manager for managing a private pool of funds in a regulated environment is to set up a VCF or a portfolio management scheme. Given that VCFs were intended to encourage financing of early stage companies, these regulations are incompatible to fund managers having an investment strategy to invest in PIPE, debt, micro finance, and the like. According to SEBI’s view, the wide variation in investment strategies desired by fund managers warranted the need to segregate various AIFs and create specific regimes for each of these strategies within an overarching umbrella regulation governing such private pools and also protecting investor interests.

The Concept Paper also indicates introduction of a separate Investment Advisor regime for all managers / advisors, including managers of AIF. It is proposed that separate regulations shall be introduced in this regard.  


Scope of the Draft Regulations

The Draft Regulations propose to create a regulatory framework which shall regulate:

(i)       all AIFs (irrespective of their legal domicile) in the security market which collect funds from institutional or high net worth investors (“HNIs”) in India; or

(ii)     managers of AIFs who manage AIFs for investments in India.

The Draft Regulations subsume the existing SEBI (Venture Capital Fund) Regulations, 1996 (“VCF Regulations”), though existing VCFs would continue to be regulated by the VCF Regulations until the fund / scheme is wound up. However, all fresh pool of capital raised by existing VCFs would be regulated under the new framework. The Draft Regulations also propose to regulate a PMS who intends to ‘pool’ assets for investments into unlisted securities.

Thus, no AIF can operate in India without registration. Additionally, all pooling vehicles (excluding VCFs which have an operating fund) already operating, including VCFs pending registration, would also have to register under these Draft Regulations within a period of six months from the commencement of the Draft Regulations.

Salient features

·         In addition to trust and companies, limited liability partnership (“LLP”) may be used as a pooling vehicle

·         Number of shareholders / partners restricted to 50 in case AIF is constituted as company / LLP.  In case of a trust, the Concept Paper indicates that up to 1000 investors could participate in the concerned AIF

·         Minimum size of the funds: increased to INR 200 millions with an option for upward revision of 25%

·         Minimum ticket size for investors: 0.1% of fund size subject to minimum amount of INR 10 millions

·         Tenure of the fund: a minimum of 5 years and extendable by up to 2 years upon receiving approval of at least 75% investors to the fund

·         Sponsor commitment: a minimum of 5% of the funds corpus by way of actual contribution to the corpus and not through waiver of management fees and to be locked in till the last investor in the concerned fund has been given an exit

·         Each fund / scheme shall require a separate registration under the Draft Regulations

·         Investment in any single investee company shall not exceed 25% of corpus of the AIF

·         The manager shall not invest directly into the investee companies

·         Unlike the current VCF regime, the Draft Regulations permit AIFs (except strategy fund) to invest in certain categories of NBFCs such as Infrastructure Finance Company, Asset Finance Company, Core Investment Company or companies engaged in microfinance activities.

·         Investors are proposed to be locked in for a minimum period of three years.

Categories of AIFs proposed in Draft Regulations

The Draft Regulations seek to make clear distinctions among the various AIFs with the intent to distinguish the investment criteria and relevant regulatory concessions that may be allowed to them. The following categories of AIFs has been identified -


Type of AIF


Investment Conditions



Venture Capital Fund

To promote new ventures using technology with innovative business ideas or early or start-up stage companies, primarily through acquisition of equity seed capital or minority stake in companies that have not been publicly listed.

·       Maximum size - INR 250 crores


·       Shall not invest in a company that is promoted by any of the top 500 listed companies by market capitalization or by their promoters


·       At least 66.66% of the investment shall be made in equity shares of unlisted companies


·       Shall not invest more than 33.33% of the fund in (i) unlisted debt or debt instruments where equity investment has been made; (ii) preferential allotment of equity shares of a listed company subject to a lock in period of one year; (iii) equity shares or equity linked instruments of financially weak company or a sick industrial company whose shares are listed


·       Shall not subscribe to warrants


·       It is proposed that VCFs may invest by way of equity shares of eligible companies and the flexibility to use any other ‘equity linked’ instruments has been withdrawn. Such restriction will severely limit structural alternatives.


·       The restriction that prevents a VCF from investing in any company promoted by promoters of top 500 listed companies seems to be without merit.


PIPE Funds

PIPE fund shall invest in shares of small sized listed companies which are not part of any market indices in exchanges having nationwide terminals

·       Shall invest at least 66.66% of the fund’s corpus in equity shares of small sized listed companies


·       Shall not invest more than 33.33% of the fund in the debt or debt instruments of a company where the  fund has already made equity investment


·       The Draft Regulations finds a way to facilitate the private equity investor take informed decision during PIPE transactions by exempting PIPE funds from SEBI (Insider Trading) Regulations, 1992 


·       It is proposed that PIPE Funds may invest only by way of equity shares of eligible companies and there is no flexibility to use any other ‘equity linked’ instruments. Such restriction will severely limit structural alternatives.


·       SEBI (Prohibition of Insider Trading) Regulations, 1992 require that PIPE Funds do not sell or deal in securities of investee companies for 5 years to claim immunity. This period seems excessively long and impractical.


·       Reference to ‘small sized’ companies creates ambiguity as to whether all non-indices entities will be treated as such or will there be other parameters used to define such entities.



Private Equity Fund


A Private Equity Fund is a fund that may invest in unlisted equity, equity linked instruments of companies which require funding to develop and grow with the primary focus on matching

medium to long term capital of investee companies

·       Shall invest at least 50% of the fund in unlisted companies


·       Shall not invest more than 50% of the fund in companies proposed to be listed


·       Shall not invest more than 50% in unlisted debt of a company where the fund has already made equity investment


·       A Private Equity Fund has been restricted to invest only in unlisted companies and unlisted debt. This restriction seems to be in disregard of the fact that a private equity strategy would include investments into listed equities or listed debt.


·       It is unclear as to what would ‘company proposed to be listed’ encompass. Would this relate to a pre-IPO investment or participation in IPO or any other company which may have a plan to list. Suitable clarity in this regard would be required.



Debt Funds


·       Shall invest at least 60% of the fund in unlisted debt, with not more than 25% of the fund in convertibles with minimum maturity of 5 years


·       May invest up to 40% in securitized debt instruments, debt securities of listed companies and equity shares of unlisted company where the fund has already made a debt investment


·       Investment into listed debt securities of unlisted entities should also be permissible.


·       Recognition of this category of fund should facilitate raising of meaningful private pool of capital to provide necessary fillip to corporate bond markets in India thereby achieving the SEBI objective of developing a vibrant debt market in India.




Infrastructure Equity Fund



·       Shall invest at least 66.67% of the fund in equity or equity linked instruments of infrastructure projects/companies


·       May invest up to 33.33% in debt instruments of companies where it has made equity investment or in securitized debt instruments of an infrastructure company or SPV of infrastructure project

·       A specialised regime for infrastructure equity funds is a welcome step as granting required concessions/ incentives to these funds could help encourage such funds being set up.




Real Estate Fund


·       Shall invest at least 75% in Real Estate Projects or fully built properties or in the SPVs


·       May invest up to 25% in allied sectors of real estate


·       Shall invest at least 66.67% in equity of equity linked instruments, and up to 33.33% in debt or debt instruments of real estate projects or SPVs engaged in real estate projects

·       While it appears that Real Estate Funds would be allowed to invest directly in real estate projects as opposed to only the holding SPVs for such project, there seems to be a disconnect with the condition of an investment of at least 66.67% in equity  or equity linked instrument.


·       Flexibility to invest in developed properties could facilitate in some form the REIT regime which has been lingering for a while.


SME Fund

A SME Fund shall invest primarily in the unlisted equity or equity linked instruments of SMEs in manufacturing, services sector as also businesses providing infrastructure or other support to SMEs as defined by the Ministry of

Small and Medium Enterprises


·       May invest in equity or equity linked instruments of SME companies which are listed or proposed to be listed in SME exchange or SME segment of Regional Stock Exchange

·       SMEs are the mainstay of the Indian economy. A dedicated fund regime would help finance such entities. Regulatory concessions could be extended to such funds to incentivise the space.


Social Venture Fund

A Social Venture Fund shall be targeted to investors who are willing to accept muted returns, say 10% to 12%


·       Shall invest in social enterprises such as MFIs which satisfy social performance norms laid down by the fund

·       Social venture funds have been allowed to invest in spaces like micro finance who typically operate under an NBFC model. Under the current laws, a VCF could not effectively invest in such structure. Considering the turmoil faced by the MFIs, this is a welcome move.


·       This will also encourage other socially relevant investments where there is a growing interest with a philanthropic intent.


Strategy Fund (Residual Category, including hedge funds)

The Strategy Fund may specify any strategy in any class of financial instruments


·       May invest in derivatives, and complex structural products subject to requirement of suitability and disclosure to investors

·       Finally a structure to facilitate creation of domestic hedge funds would be welcomed by the investors.


·       It appears that the Strategy Funds could be allowed to have an omnibus strategy. This would allow some flexibility for strategies that do not fit within the ones identified.


1.       Sponsor commitment: The higher level of compulsory sponsor’s commitment to each concerned AIF, makes it onerous for non-institutional sponsors from meeting eligibility criteria and is in clear diversion to the standard international practices where such sponsors’ commitment would typically be in the range of 1% to 2% and that too not being mandatory and allows for such contribution by way of adjustment to management fee. Further, the lock in on the sponsor’s commitment till the end of the AIF’s term, is not in consonance of distribution waterfall either in India or internationally.

2.       Minimum commitments from investors: Considering the higher risk weightage for alternate investments, SEBI’s proposal to increase the minimum ticket size for investors to participate in an AIF, is a welcome move. However, such increased limit could prove to be a barrier for HNIs from achieving risk diversification through investments in different asset classes. An alternate to this could have been to define the eligible investors who could participate in AIF structures in line with ‘accredited investors’ as recognized in other jurisdictions on the basis of net worth criterion. Further, the ticket size could have been varied across the different strategies.

3.       Offshore fund managers: The Draft Regulations seems to propose that managers of offshore fund vehicles that invest into India would need to be registered with SEBI. It is unclear whether such registration would be under the Draft Regulations or the ‘Investment Advisor’ regulations (which is separately proposed). These regulations to that extent seem to have extra territorial reach and the implications of it conflicting with regulations of other jurisdictions, seem imminent and could lead to complexities.

4.       Strategy specific registrations: The Draft Regulations propose separate registrations for AIFs adopting the different strategies (as have been identified above). The same could create complexities, including from structural perspective for multi strategy funds and those that invest across asset classes with no predetermined allocation for each class.

5.       Change of strategy or investment team: Such changes require that the AIF offer the investors to ‘positively reaffirm’ their consent to continue being invested into the concerned fund. This could potentially prove to be extremely onerous especially for institutionally backed fund managers when there is a churn within the investment professionals. Further the Draft Regulations expect that the key members of the management team devote ‘substantially all their business time’ to each fund. This could prove difficult to satisfy especially institutional backed management teams which comprise a significant portion of the domestic alternate funds industry.

6.       Unliquidated investments to be absorbed by fund manager / sponsor: The Draft Regulations expect the concerned fund should wind down within the indicated duration and buy out any unliquidated fund assets. This could be counterproductive as it may pressurize fund managers to make an untimely exit especially when the AIF is close to its winding up. This could severely impact the returns that the fund could make to its investors.

7.       Investment instruments available under strategies: The Draft Regulations seem to indicate that all fund regimes can use equity linked instruments for transaction structuring, VCFs and PIPE funds have been restricted to only ‘equity shares’. The same could significantly restrict the flexibility for structuring investments with downside protections like liquidation preference or preemptive rights or anti dilution rights for the AIF.

8.       Concessions/ exemptions: While the regulations have been in many senses made onerous, there does not seem to be commensurate regulatory concessions/ relaxations being offered to AIFs. It would be interesting to see whether the government is willing to extend concessions / relaxations to AIFs from taxation and exchange control perspective, for instance, tax pass-through for AIFs, removal of sectoral restrictions for FVCI or participation by NRIs in AIFs.

9.       Transparency and disclosure standards: By prescribing ongoing disclosure standards, SEBI has brought about consistency in the information flow to the investors by AIFs. Though desirable from an investor protection and good governance perspective, such disclosure standards would increase the administrative burden and costs.


It is truly commendable that SEBI while proposing the Draft Regulation has drawn upon the international regulatory developments in respect of alternate investment funds with specific reference to governance and investor protection. Also, the motive here seems to be to create segregated strategies under an omnibus regime allowing directed benefits to be offered to each such strategy as against the generalized approach followed so far. On the positive side, the Draft Regulations create a conducive platform for alternate investment strategies thereby increasing the suite of specialized offerings in this asset class for discerning investors. However, the extent of the regulations proposed may be overwhelming for the industry considering its yet maturing phase.




- Fundsteam

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