Alternative Investment Funds (AIFs) encompass various investment avenues, including private equity, venture capital, hedge funds, and other privately pooled instruments that target diverse assets like real estate and commodities. Typically associated with higher risks, AIFs cater to wealthy individuals or high-net-worth investors due to their complex nature and regulatory safeguard needs.
Understanding the Recent SEBI Circular
The Securities and Exchange Board of India (SEBI) recently issued a circular on October 8, which outlines more stringent due diligence requirements applicable to AIFs and their management teams. The primary objective of this directive is to tighten oversight and thwart any attempts to bypass existing regulations, ensuring enhanced compliance across the AIF landscape.
Strengthened Regulations for Qualified Buyers
The SEBI circular mandates that AIFs diligently assess both their investors and investment mechanisms to comply with regulatory standards. This is crucial for preventing ineligible participants from benefiting from provisions meant for Qualified Institutional Buyers (QIBs) and Qualified Buyers (QBs). These groups encompass substantial, sophisticated investors including banks, mutual funds, pension funds, high-net-worth individuals (HNIs), family offices, venture capital firms, and other AIFs.
Under SEBI’s (Issue of Capital and Disclosure Requirements) Regulations, AIFs qualify as QIBs, allowing them access to exclusive financial instruments, such as security receipts from asset reconstruction companies (ARCs). The latest circular compels AIFs to execute thorough due diligence when an investor contributes 50% or more to the corpus of any scheme, focusing on adherence to SEBI and the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act (Sarfaesi Act).
Addressing Loan Evergreening Concerns
One significant concern addressed by the circular is the ‘evergreening’ of stressed loans, where RBI-regulated lenders employ AIFs to circumvent asset classification and provisioning norms. This issue was underscored in a prior address by the RBI Governor, who warned financial institutions against such practices. In tandem, SEBI’s directives aim to eliminate potential avenues for regulatory evasion related to loan management.
Furthermore, AIFs must now conduct diligent checks if 25% or more of a scheme’s corpus is contributed by investors regulated by the RBI or if such investors have the capacity to sway investment decisions. These measures aim to deter AIF managers from indirectly facilitating control by RBI-regulated lenders over investee companies beyond what regulations allow.
Implications for Foreign Investments
SEBI’s October 8 circular emphasizes that due diligence must comply with the standards established by the Standard Setting Forum for AIFs (SSF), particularly for foreign investors or funds based outside India. This assessment should be conducted on a look-through basis, evaluating the overall profitability of the investment structure. Any investor failing these checks must be excluded from participation in the scheme.
Cross-Border Regulations
The regulations further specify that entities from countries sharing a land border with India must secure government approval prior to investing in Indian firms. If an AIF obtains 50% or more of its corpus from such entities, it is mandated to execute due diligence in alignment with SSF standards. Should an AIF hold 10% or more in equity-linked securities of any investee company, it is obligated to notify its custodian within 30 days of the investment, while the custodian has the duty to report this data to SEBI by May 7, 2025.
Expert Perspectives on Regulatory Changes
Experts acknowledge the potential compliance challenges introduced by the new regulations. Brijesh Damodaran, founding partner at Auxano Capital, stresses the balance between maintaining a robust regulatory ecosystem and inviting capital into the market. He points out that not all investments may fit the desired framework for sustainable growth.
Concerns arise regarding how these regulations may deter large investors from certain AIFs, as the increased compliance and reporting requirements could complicate the investment landscape. According to Puneet Sharma, CEO of Whitespace Alpha, while diversified AIFs may not feel a significant impact, those with concentrated investor bases will likely need to allocate more resources to ensure compliance, potentially affecting their appeal to high-net-worth individuals and institutional investors.
The circular essentially reinforces the regulatory architecture designed to prevent AIFs from being misused by RBI-regulated entities to circumvent regulations. Failure to comply could signify a regulatory breach, underscoring the urgency for AIFs to align their operations with the newly established compliance standards.
