SEBI Issues 5 Consultation Papers Proposing Changes to the AIF Regulations

In furtherance of its endeavour to review the regulatory norms on alternative investment funds (“AIFs”), the Securities and Exchange Board of India (“SEBI”), on February 3, 2023, issued five consultation papers containing such proposed alterations. Each such consultation paper discussed one proposed aspect of review—detailing the objective, background, issues for consideration, and proposal in relation thereto. The points of review are as follows:

1. Eligibility criteria for the key investment team and prescribing qualification for compliance officer of manager of AIF under the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”):

Regulation 4(g) of the extant AIF Regulation sets out the eligibility criteria the key investment team of the manager of an AIF is required to have. Highlighting the fact that such requirements may act as barriers to new age managers with the requisite expertise in fund management and generating returns for the investors, the subjective nature of the experience criteria, the lack of specific experience requirements under the SEBI (Mutual Funds) Regulations, 1996, etc.; SEBI proposed that the extant experience criteria for the key investment team member(s) of the manager of an AIF, under the AIF Regulations be replaced with a requirement of obtaining a relevant certification from an institution notified by SEBI. It further proposed that the compliance officer of such manager also be required to obtain relevant certification from an institution notified by SEBI.

2. Requirement of investor consent for AIFs dealing with their associates while buying or selling investments:

The consultation paper first provided backdrop by setting out the meaning of “associate” under the AIF Regulations—a company/LLP/body corporate in which a director/trustee/partner/ sponsor/ manager (or director/ partner of the manager/ sponsor), either individually or collectively holds more than 15% of its paid-up equity share capital/ partnership interest. It restated the norms which the AIF Regulations specify in relation to dealing with associates and went on to propose that AIFs be mandated to take the approval of 75% of the investors (by value of their investment in the AIF), for buying or selling investments from/to: (i) associates; or (ii) schemes of AIFs managed/sponsored by its manager, sponsor or their associates.

3. Dematerialization of units of AIFs:

The AIF Regulations provide that AIFs or schemes may raise funds from any investment by way of issuance of (fully/ partly paid-up) units which represent beneficial interest of the investors in the scheme. These units are “securities” under the Securities Contracts (Regulation) Act, 1956 and the depositories have laid down procedures for their dematerialization. Noting that despite these procedures being in place, the units of most AIFs are held in physical form; SEBI proposed that the dematerialization of units of AIFs be made mandatory. As the first phase of this mandate, SEBI proposed that by April 1, 2024, all schemes of AIFs with a corpus exceeding Rs. 500 crores must compulsorily dematerialize their units.

4. Direct plans for schemes of AIFs and the introduction of trail model for distribution in AIFs:

Currently, under the AIF Regulations, AIFs may offer a direct plan for investors in their Private Placement Memorandum (“PPM”) at their option. Such a direct plan would not entail any distribution or placement fees for the investor. The AIF Regulations do not place restrictions on how much of any distribution commission or placement fees can be paid to intermediaries upfront. Accordingly, it was proposed that investors may be charged a placement fee/ distribution fee on trail basis for all categories of AIFs. However, for Category I and II AIFs, certain higher amount of such fee (1/3^rd of the present value of the total distribution fee) may be paid to the distributor in the first year.

5. Providing AIFs and their investors the option to carry forward unliquidated investments of a scheme upon expiry of its tenure under the AIF Regulations:

The list of options available to AIFs/ managers upon the expiry of the tenure of a scheme of AIF was provided as a background. It was then proposed that at the end of a tenure of a scheme beyond two years and at the end of extended tenure of LVFs, the AIF/ manager may close the existing scheme and transfer the unliquidated investments to a new scheme, subject to obtaining consent of 75% of investors by value and the fulfilment of the provisos stipulated in the consultation paper. In the event the consent of such 75% investors is not received either for in-specie distribution or for transfer to a new scheme per the stipulated terms, the AIF/manager would be required to liquidate the investments at liquidation value within a year of expiry. It further specified that the manager and trustee would be responsible for compliance of the aforesaid procedure.

SEBI’s bifurcated, streamlined and matter-specific approach to inviting comments from the public and stakeholders will likely result in the recommendations/ comments being scrutinized thoroughly and lead to the effective recalibration of the regulatory norms of AIFs.