Such CIF vehicles, they believe, must comply with extra compliance standards to minimise the use of fund vehicles to sidestep other laws. Also, if a single investor in an alternative investment fund (AIF) – the regulatory term for PE and VC pools – contributes more than 50% of the corpus, it should not enjoy the status and benefit of qualified institutional buyers (QIBs) which receive the highest allocation in initial public offerings (IPOs).
Even though an industry-wide consensus is yet to be reached on the subject, a number of AIF managers are taking such positions with the Securities and Exchange Board of India (Sebi) having made it clear that it would like to put an end to deals that are cut to circumvent different financial regulations. Such practices, according to the regulator, could erode trust in the system.
Under the regulations, if the asset management company of an AIF is controlled by residents, then the money in the AIF is considered local even if all investors in the fund are foreign. The rule is believed to have been used by some of the foreign investors to own more than what is permissible under foreign direct investment in certain domestic companies. Even local promoters may use AIFs to have indirect ownership over and above their declared holdings in listed companies.
A framework to curb such transactions was proposed in a consultation paper released by Sebi in January to sound out the AIF industry. The paper suggests that “every AIF, manager of the AIF and Key Management Personnel of the Manager and the AIF, shall carry out specific due diligence, as may be specified by Sebi from time to time, with respect to their investors and investments, before each investment, to prevent facilitation of circumvention of extant regulations administered by any financial sector regulator.”Such a rule, according to some of the senior AIF officials ET spoke to, is too sweeping and makes the burden of regulatory compliance across the industry onerous – an obligation that other financial services entities are not subject to. “Sebi’s concerns are valid. But, instead of asking all AIFs to carry out such due diligence, such a regulation, we feel, should be confined to CIFs which are more prone to carry out transactions that amount to bypassing other financial and securities regulations,” said an industry official responding to the consultation paper. It is felt that for broad-based AIFs, having several investors, such concerns are comparatively less.”Besides, many AIFs are open to giving an undertaking that funds would not be used to evergreen loans,” said the person. The Reserve Bank of India (RBI), however, has virtually banned such transactions by restraining banks and NBFCs from investing in AIFs which fund companies that have borrowed from the same banks and NBFCs.Current regulations though have no definition of concentrated funds or CIFs. “If such a regulation is brought in, a CIF would have to be defined. Such a fund could be an AIF having a total number of investors below a certain threshold, say 5 or 10. Also, where at least one of the investors has a say in the fund’s investment decisions or has an ownership or control over the fund management entity,” said another AIF official.
According to them, such funds should ideally give an undertaking that they would not make any investment which the investor(s) in the fund cannot directly make.
“Taking a cue from what’s outlined in the consultation paper, such concentrated funds having a few investors should not be categorised as QIB. A number of funds have separately given their feedback to the consultation paper as well as to some of the committees constituted by the regulator. Sebi has yet to spell out the shape that the final regulation could take. But the sense we get is that the regulator would like to have a proposal placed before its board as early as possible,” said another person.
In the past three years, a slew of regulations have been brought in by Sebi to keep a closer vigil on AIFs with the industry growing at 25% every year. There are more than 1,000 AIFs registered with Sebi.