The regulatory framework governing alternative investment funds (AIF) has recently been amended in important ways, clarifying the regulatory intent of the Securities and Exchange Board of India (SEBI).
The first key amendment was the Securities and Exchange Board of India (Alternative Investment Funds) (Amendment) Regulations, 2020, dated 19 October 2020 (the amendment regulations), which stipulates educational qualifications and professional expertise thresholds for the key investment team of an AIF’s manager. Hitherto, AIFs could customize fund documents and set out guidelines as regards the administrative affairs of the AIF, including the qualifications and expertise standards of the management team. Hence, by now stipulating specific qualifications for the invest- ment team, the SEBI seems to have restricted the rights of AIFs to have independent and customized management policies.
The second key amendment introduced by the amendment regulations explicitly places the responsibility for all investment decisions of the AIF on the manager. Additionally, the SEBI has expressly permitted managers to constitute investment committees (IC) to approve the investment decisions of AIFs. Moreover, it has now made members of ICs equally responsible with managers for the AIF’s investment decisions and compliance with the provisions of the SEBI (Alternative Investment Funds) Regulations, 2012 (AIF regulations) and its fund documents.
The amendment regulations further stipulate that any external members not disclosed in the placement memorandum or other fund documents, can be appointed to the IC only with the consent of at least 75% of the investors by value of their investment in the AIF.
Placing members of ICs on the same footing as managers is likely to have undesirable consequences, since most investors typically appoint their nominees to ICs to ensure their general involvement in the management and supervision of the AIFs’ activities.
Placing the same levels of responsibility as managers on them may result in a reluctance to take up IC memberships. This will also hamper the flexibility that AIFs have had until now in terms of the constitution and management of their ICs.
Clause 4 of schedule VIII to the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (NDI clause), stipulates that investments made by an investment vehicle in an Indian entity will be regarded as indirect foreign investment if the manager is owned or controlled by persons resident outside India. In light of this, the SEBI has put on hold the applications for registration of funds whose IC’s include non-resident external members. It issued a circular on 22 October (circular) clarifying that such applications will be processed only after the government or the Reserve Bank of India clarifies whether the NDI clause will apply to such AIFs.
According to the AIF regulations, the eligibility criteria for qualifying as an angel investor include specific minimum net-worth criteria for individual and corporate investors. It was in the context of such minimum net-worth criteria that an AIF sought certain clarifications from the SEBI. The investment matrix involved a group of individual investors who desired to use a limited liability partnership (LLP) in which they were constituent partners to invest in an angel fund for succession and estate planning purposes.
In its interpretative letter dated 17 September, the SEBI clarified that the minimum net-worth criteria is a statutory requirement that every individual or entity seeking to qualify as an angel must individually fulfill. Hence, an LLP formed by a group of individual investors who each meet the prescribed net-worth criteria will not qualify to be an angel, as an LLP is a separate legal entity and it must therefore also meet the minimum net-worth criteria as stipulated for a body corporate under the AIF regulations.
On a cumulative reading of the amendment regulations, the circular and the letter, the need for light-touch regulation of privately pooled funds such as AIFs that may have global investors, seems particularly necessary. Now more than ever, it is incumbent on the government to facilitate the inflow of investments and cash flow by bringing about the cautious easing of restrictions. A conscious adoption of a harmonious and judicious interpretation of the AIF regulations would be useful in the interests of attracting investments into India, particularly in times like these when both domestic and global economies have been stretched thin.
Nivedita Nivargi is a partner and Vineetha Stephen is an associate at Samvad Partners
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