Alternative investment funds are poised for growth

By Jay Gandhi and Abhishek Parekh, Shardul Amarchand Mangaldas & Co

Recent years have seen significant growth in alternative investment funds (AIF), domestic privately-pooled investment vehicles for private and public market investments. Belying the general economic slow-down following the covid-19 pandemic and the Russia-Ukraine war, commitments to AIFs grew to INR6.94 trillion (USD8.43 billion) by June 2022. This is a growth of 42% over the year from June 2021 and an increase of more than 600% from INR960 billion in June 2017. The average size of AIFs has grown rapidly, with higher fundraising in a typical AIF. The number of AIFs registered in India has also significantly increased to almost 1,000 over the ten years since the introduction of AIF regulations, nearly tripling from the 346 AIFs in June 2017.

In an indication of the increasing regulatory importance of AIFs, the Securities and Exchange Board of India (SEBI) has made many changes to existing regulations, bringing greater checks and balances to the AIF ecosystem. In this article, we discuss certain key regulatory updates impacting the AIF industry, as well as the underlying trends behind these changes.

Jay Gandhi
Shardul Amarchand Mangaldas & Co

A significant trend is an emphasis on the governance and decision-making frameworks within which AIFs operate. In May 2021, the SEBI introduced a code of conduct applicable to all AIFs, in line with the regulations applicable to other regulated financial intermediaries. It was common for members of the investment committee (IC members) of AIFs to take part in the investment and divestment decision-making process but the regulations did not specifically deal with or regulate this. In its initial guidance, the SEBI directed that IC members would be held responsible for ensuring that the AIF was in compliance with all applicable laws. However, following feedback from the market participants, the SEBI amended the regulatory position to limit the responsibility of such IC members to ensuring investments comply with the policies and procedures of the AIF. While this is an unusual mechanism, even in its diluted form, it appears that the SEBI did not want entities or individuals other than the asset management company and its teams to make investment and divestment decisions without regulatory supervision or oversight.

Another trend in the AIF industry is the deployment of sophisticated and complex investment strategies by fund managers who manage institutional wealth and high-risk capital. The SEBI has been in constant touch with the market participant community and has provided the needed clarifications and directions to facilitate growth. Recognising that sophisticated investors require lesser governance, the SEBI in 2021 introduced the concept of large value funds for accredited investors. Its aim was to provide a light-touch regulatory regime for accredited investors with a larger risk appetite and the ability to evaluate risks appropriately. Such investors were those committing not less than INR700 million to the AIF. Key benefits for large value funds included the relaxation of concentration norms, certain offer document filing requirements, waivers for holding the IC members from collective responsibility for investment decisions and the flexibility and relaxations on the tenure requirements for close-ended funds. Similarly, the SEBI recently liberalised an earlier requirement under the regulations that an overseas investment company needed to have an India connection. This has opened up a wider investing horizon and a plethora of opportunities for Indian AIF managers to deploy a portion of their capital abroad.

Abhishek Parekh
Shardul Amarchand Mangaldas & Co

The AIF regulations have been amended, giving impetus to asset managers to deploy capital into high-priority sectors. The introduction of a new category of special situation funds is a prime example of this, where such AIFs were permitted to invest in or acquire stressed loans from banks and other financial institutions. Similarly, the social venture fund framework under the AIF regulations that had not gained sufficient traction was completely overhauled and replaced by the social impact fund regime. This is tailored for investors who focus on impact and environmental, social and governance investing.

The SEBI has proactively reconstituted its alternative investment policy advisory committee to seek advice on hurdles to the development of the alternative investment industry as well as the development of the start-up ecosystem. With steps being taken in the right direction, the AIF industry is expected to grow significantly and become a mainstream alternative investment option.

Jay Gandhi is a partner and lead for the investment funds practice, and Abhishek Parekh is a partner at Shardul Amarchand Mangaldas & Co.

Shardul Amarchand Mangaldas & Co

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Disclaimer: This article is intended to provide a general guide to the subject matter. Specialist advice should be sought on readers’ specifics circumstances. The views in this article are the personal views of the authors.