Complying with Sebi's new rules will be challenging, onerous: AIF industry

Some believe alternative investment funds may face teething issue but the regulatory changes will eventually improve governance

The Rs 7-trillion alternative investment fund (AIF) industry is feeling the heat, thanks to a host of regulatory changes announced by the Securities and Exchange Board of India (Sebi).

Some of the fresh changes include standardised approach to valuation, treatment of unliquidated investments, mandatory dematerialisation of units and certification requirements for key employees.

Industry players say complying with the new framework will be a challenge, particularly the move that mandates all new schemes and existing AIFs with a corpus of more than Rs 500 crore to dematerialise their units by October 31.

"Dematerialisation of AIF units should have been kept optional initially, based on limited partners’ (LP) requests, for the markets to adjust to operational challenges,” said Rajeev Saptarshi, chief operating officer, Kotak Investment Advisors Ltd (KIAL). “As AIFs are privately placed funds, they don’t currently issue units. Instead, they issue a statement of account, like mutual funds (MFs). Smaller funds and offshore investors may find this move cumbersome. While we will wait for a detailed circular, the benefits of this move are not apparent,” he added.

AIFs have so far received commitments worth over Rs 7 trillion and have made investments worth more than Rs 3 trillion.

Some have expressed surprise that the rules around dematerialising of units and certification are being applied to the AIF industry, which is relatively new, but not to the Rs 40-trillion MF industry.

Sebi has maintained that the changes, to be enacted soon, are aimed at protecting investors from fraud.

To address the issue of investments that are not sold due to lack of liquidity during the winding-up process, Sebi has said that on the approval of 75 per cent investors by value, AIFs will be allowed to sell such investments to their own new scheme. Sebi has also introduced a provision for writing off investments for which the investors are not willing to take in-specie distribution. (In-specie is the transfer of an asset in its present form rather than in its value in cash.)

Though the industry has welcomed some provisions, it has cited issues around higher tax outgo and challenges for assets under litigation.

“The requirement to move investors and assets into a new fund could lead to potential tax issues and may be detrimental to investors of a fund where assets are under litigation,” Saptarshi said, adding, “Hence, in our view, the existing fund should have been permitted to continue with separate rules governing such funds including on carrying value of assets post the end of the term.”

Some believe the industry may face teething issues around the new norms but these will eventually improve its governance standards.

“There could be some pushback from LPs on the writing-off of investments, which the managers will have to deal with in accordance with their fiduciary duties. The regulator can't be expected to provide solutions for commercial challenges,” said Vivaik Sharma, partner, Cyril Amarchand Mangaldas. “But AIFs will now have more options to resolve unsold assets and wind up on time, which could have been challenging earlier. At present, there is no clear cut resolution if investors reject in-specie distribution of illiquid assets.”

Further, the market watchdog has asked AIFs to appoint an independent valuer for valuing the investment portfolio of AIFs, including those of Category-III in unlisted securities and listed debt securities. The regulator has also cast responsibility on managers of AIFs for true and fair valuation, lapses on which could lead to severe action.

Besides this, Sebi is replacing the existing ‘minimum experience requirement’ with a ‘certification requirement’ for key investment managers as the eligibility criterion for AIF registration.

“There are concerns on the practicability of the mandatory certification requirement proposed to replace the current minimum experience criteria for key investment teams. This might be similar to the requirements under Sebi Investment Advisers regulations, which have been onerous, specifically for experienced managers,” Sharma said, adding, “Retaining the minimum experience criteria as an alternative to the certification criteria would be more prudent.”

What changes for AIFs
 

• Dematerialisation of units for new schemes and existing funds with corpus of over Rs 500 cr by October 31, 2023
• For all others, dematerialisation to be done by April 30, 2024
• At present, AIFs don’t issue units but a statement of account
• Minimum experience for eligibility of key team replaced with mandatory certification requirement
• Flexibility to transfer unliquidated assets to a liquidation scheme giving some extension
• Mandatory in-specie distributions during winding up or write-off investments
• Framework for valuation and eligibility criteria for independent valuer
• Approval of 75% investors for deals involving conflict of interest