SEBI plans to restrict borrowing by AIFs to prevent systemic risk

Market regulator also proposes mandatory renewal of AIF registrations on completing five years

The Securities and Exchange Board of India (Sebi) plans to bar category I and category II alternative investment funds (AIFs) from borrowing or engaging in leverage for the purpose of investments to prevent systemic risk.

Between June 2022 and March 2023, AIFs borrowed funds to the tune of Rs 708 crore, Sebi observed in a discussion paper on strengthening governance mechanisms at AIFs.

Of this, only Rs 7.5 crore was borrowed to meet operational expenses. The regulator feels that funds borrowed by Category I and II AIFs for investing in unlisted securities may lead to asset-liability mismatches.

However, AIFs will be allowed to borrow in emergency and as a last resort so that they do not miss an investment opportunity due to the shortfall in drawdown from an investor, Sebi has proposed.

Such borrowings, however, will have to be limited to 10 per cent of the investment made in an investee company and the cost of borrowing will only be charged on the investor who delayed or defaulted on the drawdown payment.

The funds will have to maintain a cooling-off period of two months between any permissible leverage.

Sebi is also mulling over the idea of preventing AIFs from holding registration indefinitely without any commitments raised by mandating the renewal of registration. There are 215 AIFs with registrations, which have not raised any investment commitment for any of their schemes.

On completing five years, all AIFs will have to pay a renewal fee equal to 50 per cent of the registration fee within three months before the registration expires.

In case the AIFs fail to pay the renewal fee, then a late fee of 2 per cent of the registration fee will be charged for each day of delay, up to a maximum of twice the registration fee.

Under the proposed amendments, Sebi will also mandate the appointment of custodians for all AIFs, irrespective of the size of the corpus. Upon approval, existing AIFs with a corpus of less than Rs 500 crore will be given six months to appoint a custodian.

The custodians will also be given the responsibility of independently monitoring the investments made by AIFs, similar to their responsibilities for foreign portfolio investors (FPIs).

Sebi has also sought comments on the proposal to permit large value funds (LVFs) to extend their tenure up to four years on the approval of two-thirds of the unit holders by value. Under the present regulations for closed-ended funds, a majority of the LVFs are able to extend their tenure only for two years, subject to consent from the investors.

The regulator has also proposed that investments by AIFs be dematerialised for easy monitoring and to enhance transparency. In its last board meeting, Sebi had mandated that AIF units be dematerialised.

Keeping a check 

Between June 2022 and March 2023, AIFs borrowed funds worth Rs 708 crore

Of this, only Rs 7.5 crore was for operational expenses

Funds borrowed by Category I and II AIFs for unlisted securities may lead to asset-liability mismatches, says Sebi However, AIFs will be allowed to borrow during emergencies