The proposed Sebi Alternative Investment Funds Regulations appear to be in conflict with the stated intention of not regulating existing venture capital funds registered with Sebi, as they restrict existing venture capital funds from completing subsequent round of closings.
The Securities and Exchange Board of India, approved the Sebi (Alternative Investment Funds) Regulations, 2012 in its board meeting held on April 2, 2012. According to the press release issued by Sebi in this regard, the Sebi AIF Regulations are to become effective from the date of their notification in the Gazette of the Government of India.
The decision of the Board is a follow-on from the concept paper and the draft AIF Regulations issued by it in August 2011 for public comments. The Draft Regulations rightfully acknowledged Alternative Investment Funds as an asset class distinct from promoter holdings, creditors and public investors, and proposed classification of AIFs into specific categories to provide for a comprehensive framework to regulate these taking into account their individual investment strategies.
Venture Capital Funds, presently governed by the Sebi (Venture Capital Funds) Regulations, 1996, were identified as one such category of AIFs proposed to be brought under the purview of the Sebi AIF Regulations. The Draft Regulations contemplated that once the AIF Regulations came into force the VCF Regulations would be repealed. That said, existing VCFs were to continue to be regulated by the Sebi VCF Regulations till the existing fund or scheme managed by the VCF was wound up. Therefore, it was anticipated that unless an existing VCF proposed to launch another scheme, it would continue to be governed solely in accordance with the Sebi VCF Regulations.
The salient features of the Sebi AIF Regulations pertaining to VCFs, as highlighted in the Sebi press release, appear to be in line with the Draft Regulations – however, with one important difference. Thus, while existing VCFs would continue to be regulated by the VCF Regulations till the existing fund or scheme managed by the fund was wound up, these VCFs would not be permitted to raise any fresh funds after notification of the Sebi AIF Regulations, except to the extent of commitments already made by investors as on date of the notification.
While the full import of this may only be ascertained once the Sebi AIF Regulations have been notified and their complete text made available, a plain reading of the aforesaid suggests that existing VCFs registered with Sebi would be restricted from raising any further capital, except to the extent already committed by the investors as on the date of the notification of the AIF Regulations. This may pose a challenge to existing VCFs, which have completed their first round of closing based on commitments received from investors and intend to achieve capital commitment for an amount equivalent to the total size of the fund, as disclosed to Sebi, by way of one or more rounds of closings. Such VCFs may have to re-register themselves under the Sebi AIF Regulations, which would require approval of 66.67 per cent of their investors by value.
The intent behind inclusion of such a restriction is not clear and appears to equate the raising of fresh capital by the VCF under existing schemes to achieve the total fund size with the launch of new schemes. Such provision also seems to overlook the fact that under the extant VCF Regulations, VCFs are merely required to solicit a minimum capital commitment of Rs 5 crore from its investors at the time of seeking registration with Sebi. As a result, practically every VCF performs several rounds of closing, either by way of increase in the capital commitment from its existing investors or by inducting additional investors in the VCF to achieve the total fund size.
In this regard, it may be appreciated that the manner in which capital may be raised by VCFs is regulated by Sebi, and VCFs are required to strictly adhere to the conventions approved by Sebi for fund raising. In addition, disclosures made by VCFs to Sebi at the time of seeking registration typically include the investment strategy, the total size of the fund, the minimum capital commitment from investors as well as the threshold amount to be raised for the fund to be operational. To now require existing VCFs, which are in the process of raising capital to achieve the total fund size, to realign their operations as per the Sebi AIF Regulations is not only likely to present practical difficulties but also give rise to anomalous situations, wherein VCFs may potentially be governed by two separate regulations in relation to the same set of investors.
Undoubtedly, the intention behind framing of the Sebi AIF Regulations is well meant and aimed at encouraging creation of domestic pool of capital for growth of ventures in a structured manner, which would consequently reduce the reliance on foreign source of capital. However, it is hoped that the final set of regulations provide greater clarity on the manner in which existing VCFs are to be regulated and facilitate these VCFs to conduct their operations in the manner contractually agreed upon with their investors, a relationship that Sebi has always sought to respect.
(The authors are lawyers at Luthra & Luthra, Law Offices. Views expressed are personal.)