The Securities and Exchange Board of India (SEBI) recently amended the SEBI (AIF) Regulations, 2012. The amendment introduces several regulatory changes to the framework for governance of alternative investment funds (AIFs) in India. One of the most critical changes brought under the new AIF regulations is with regard to the individual liability of members of the investment committee.
Under the new AIF regulations, investment committee members shall be equally responsible as the investment manager of an AIF for investment decisions. It imposes a joint and severable liability on the investment manager and members of the investment committee to ensure compliance with the AIF regulations. However, in doing so, the SEBI has overlooked certain functional and practical aspects for which an investment committee is constituted. Therefore, the amendments introduced can potentially be counterintuitive to the growth of the fund industry in India.
Risks and rewards
The amended AIF regulations will increase the investment committee’s control over the investment-making process. The extension of liability to the investment committee, in practice, will be equivalent to delegation of the decision-making power to the investment committee from the investment manager. That is to say, owing to heightened risks, committee members will demand more authority over the investment process, which will result in dilution of control from the manager.
Committee members are selected for their domain knowledge, independence and expertise to serve a guiding or supervisory role in the formation of investment strategy. However, placing the responsibility on them curbs their independence and will be an impediment in the formation of the committee. Committee members may now demand additional incentives to join, since it also involves a duty of regular oversight over the functioning of the AIF. This will result in additional expenses for the fund manager.
Non-resident committee member: Cause of conflict?
Under the government’s consolidated FDI policy, an AIF that is owned or controlled by a resident Indian citizen is treated as a domestic AIF. The definition of control under the Consolidated FDI Policy 2020 includes the “right to control the management or policy decisions exercisable by a person, or persons”.
Since post-amendments the committee can now also effectively influence or control policy and investment decisions of the AIF, the presence of non-residents on the committee has created uncertainty regarding the residential status of the AIF.
A domestic AIF is not required to act in compliance with the FDI policy, whereas a foreign AIF is mandated to do so. Hence, this is a critical demarcation, because it can affect the legitimacy of an AIF’s decisions, and, in turn, result in legal exposure for the manager and committee, from a foreign exchange control perspective, if the position is not soon clarified.
The recent amendments, as far as liability of the committee is at par with the manager is considered, are inconsistent with global standards, and seem to be an instance of unnecessary regulatory overreach. The amendments adversely affect the decision-making process of the managers of AIFs in India. This demands special attention because the Indian fund industry is at a nascent stage and requires impetus for further growth. To this end, it will be interesting to see how these changes play out in practice.
National University of Study and Research in Law