On 07.05.2024, the Securities and Exchange Board of India (‘SEBI’) issued a circular [i] (‘Master Circular’) consolidating and updating the regulatory framework of alternative investment funds (‘AIFs’).
This Master Circular issued under s. 11(1) of the SEBI Act, 1992 (‘Act’), integrates the provisions of various circulars issued by SEBI under the SEBI (Alternative Investment Funds) Regulations, 2012 (‘AIF Regulations’), up to 31.03.2024, replacing the previous Master Circular for AIFs dated 31.07.2023. It emphasises that any additional directions issued by SEBI will remain in effect alongside the provisions of this Master Circular and other applicable laws, ensuring comprehensive regulation of AIFs.
Beyond the specific requirements outlined in the Master Circular, which is discussed further, AIFs must adhere to other SEBI mandates applicable to market intermediaries. These include:
Levy of goods and services tax (‘GST’) on SEBI fees.
Securities market data access.
Digital payment.
Information on grievance redressal mechanism.
Outsourcing guidelines of activities by intermediaries.
This Master Circular came into effect on the date of its issuance. Consequently, circulars listed in Annexure 17 of this Master Circular have been rescinded. However, this rescission does not nullify actions taken under the previous circulars. Specifically:
Continuation of Actions: Any actions taken or purported to have been taken under the rescinded circulars, such as registrations, approvals, fee collections, suspensions, cancellations, inspections, investigations, or show cause notices, will be deemed to have been done under the provisions of this Master Circular.
Pending Applications: Applications made to SEBI under the rescinded circulars, if pending, will be considered as made under the provisions of this Master Circular.
Preservation of Rights and Obligations: The previous operation of the rescinded circulars or any actions taken under them, including acquired rights, privileges, obligations, or liabilities, and penalties for violations, will remain unaffected as if the rescinded circulars were still in effect.
Key Provisions
A. Online filing system
SEBI has mandated an online filing system for all entities wishing to register as AIFs and those already registered. SEBI-registered AIFs must use the same portal to file compliance reports and submit any requests under the provisions of AIF Regulations and associated circulars.
B. Standardised template for private placement memorandum (‘PPMs’)
The PPM is crucial for providing essential information to prospective investors. SEBI mandates a standardised template for PPMs to ensure minimum disclosure standards are met. The template consists of two parts: Part A for minimum disclosures and Part B for additional information. AIFs must include a detailed tabular example of fee application and distribution waterfall in their PPMs.
Reg. 11(2) of the AIF Regulation necessitates the inclusion of disciplinary action history in the PPM. This encompasses disciplinary actions against the AIF, sponsor, manager, trustees, or trustee company directors. The history should detail litigations, penalties, disputed tax liabilities, and more for the past five years.
SEBI-registered merchant bankers are essential for PPM filing and ensuring due diligence. The first scheme must close within 12 months of SEBI communication and meet specified corpus requirements.
An annual PPM compliance audit is mandatory, with exceptions for some funds. Changes to PPMs must be communicated to investors and SEBI within one month of each financial year’s end, allowing an exit option for significant changes. Ch. II of the Master Circular elucidates more on it.
C. Registration-related clarifications in ch. III
A fresh application for registration under the AIF Regulations is required if an applicant fails to submit the registered trust deed or partnership deed within the specified time. The circular clarifies that only AIFs with no investments under their initial category may apply for a category change. Application for change must include an updated Form A, supporting documents, and rationale, with a fee of Rs. 1 lakh. AIFs with prior commitments must offer investors the option to withdraw funds without penalties. No investments other than liquid funds/bank deposits are allowed until SEBI approves the category change. Upon approval, a revised PPM must be sent to all investors.
D. Investment in AIFs
AIFs can raise funds from any investor (Indian or foreign), provided foreign investors’ market regulators are signatories to the relevant memorandum with SEBI. Conditions regarding the investors are mentioned in the Master Circular ch. IV.
E. Operational and prudential norms for Category III AIFs
Ch. V of the Master Circular mentions the operational and prudential norms for Category III AIFs. Category III AIFs have flexibility in calculating investment concentration norms using either investable funds or net asset value (NAV), which must be disclosed in the PPM and remain consistent throughout the scheme’s term. When using NAV, investment limits are based on the previous business day’s NAV, excluding borrowed funds, and adjusted for market gains/losses.
F. Norms for special situation funds (‘SSF’)
Ch. VI of the SSF norms delineates precise regulations for these funds. It mandates a minimum corpus of Rs.100 crore. It requires investors to commit at least Rs.10 crores, with accredited investors allowed a minimum of Rs.5 crores, and employees or directors of the SSF or its manager obliged to invest a minimum of Rs.25 lahks. SSF intending to participate in Insolvency and Bankruptcy Code proceedings must meet eligibility requirements. Additionally, SSF can acquire stressed loans under clause 58 of the RBI Master Direction, subject to inclusion in its Annexure. There is a six-month lock-in period unless the loan is recovered, and initial and continuous due diligence for investors is mandatory, akin to requirements for Asset Reconstruction Companies.
G. Regulations for overseas investments by AIFs
Reg. 15(1)(a) of the AIF Regulations allows AIFs to invest in securities of companies incorporated outside India, subject to RBI and SEBI guidelines. AIFs may invest in equity and equity-linked instruments of offshore venture capital undertakings up to a total limit of USD 1500 million. Ch. VII mentions the guidelines for overseas investments by AIFs. It includes investment conditions, allocation of overseas investment limits and reporting mechanisms.
H. Investment in units of AIFs
Ch. VIII of the AIF Regulations elaborates on the guidelines for investing in units of AIFs. AIFs are empowered to invest in investee companies up to a specified limit, either directly or through units of other AIFs, without necessitating the classification of the fund as a Fund of AIFs. Existing AIFs are also permitted to invest simultaneously in securities of investee companies and units of other AIFs, contingent upon making appropriate disclosures in the PPM and obtaining the consent of at least two-thirds of unit holders by value of their investment in the AIF. PPM disclosures for investments in units of other AIFs should encompass details such as proposed allocation of investment, attributable fees and expenses, compliance processes, and particulars of investments in units of other AIFs managed or sponsored by the same Manager/Sponsor or their associates. Furthermore, the creation of pooling vehicles solely for investing in an AIF necessitates registration with SEBI as AIFs to align with regulatory stipulations. These regulations aim to foster transparency and adherence to regulatory norms in investment practices involving units of AIFs.
I. Participation of AIFs in credit default swaps ('CDS')
Regulations enable AIFs to engage in CDS subject to specific conditions. Category I and II AIFs can buy CDS for hedging purposes, while Category III AIFs can buy CDS for hedging or other purposes within permissible leverage limits. Category III AIFs selling CDS must ensure leverage is within specified limits and may sell CDS by earmarking unencumbered Government bonds/Treasury bills equal to the CDS exposure. Reporting obligations are outlined for AIFs and custodians, with consequences for breaches of leverage limits.
Any unhedged position exceeding twenty-five per cent of investable funds requires notification from all unit holders. Category I and II AIFs transacting in CDS must maintain a thirty-day cooling-off period between borrowing or leveraging activities. All CDS transactions must occur on regulated platforms, and compliance with RBI directives ensures compliance.
J. Transaction in corporate bonds through request for quote (‘RFQ’) platform by AIFs
AIFs are mandated to undertake at least 10% of their total secondary market trades in Corporate Bonds by value on the RFQ platform. Transactions on the RFQ platform can be either ‘one-to-one’ or ‘one-to-many’ mode. However, transactions with AIFs on both sides must occur in ‘one-to-one’ mode, while transactions with other AIFs are executed in ‘one-to-many’ mode.
K. Other clarifications
Ch. XI clarifies and regulates various aspects of AIF operations, such as investments, AIF schemes that have adopted priority in distribution among investors, and the calculation of the tenure of AIF close-ended schemes.
L. Accredited investors (AIs)
Ch. XII introduces the framework for AIs in the securities market, providing flexibility in investment amounts and concessions from specific regulatory requirements. AIs must approach Accreditation Agencies for accreditation, which are responsible for verifying documents, processing applications, maintaining data, and ensuring confidentiality.
M. Obligations of managers, sponsors, and trustees of AIF
Ch. XIII mandates that each AIF appoint a Compliance Officer to ensure adherence to the SEBI Act, AIF Regulations, and circulars. Key personnel must be disclosed in the PPM, and updates must be promptly communicated. A SEBI-registered custodian must be appointed for safekeeping securities before any investment. Managers must adhere to a stringent code of conduct, prioritise unitholders’ interests, and comply with the Stewardship Code and SEBI guidelines for transparency and ethical management.
N. Compliance reporting as per ch. XV
The trustee or sponsor of an AIF must ensure that the compliance test report (‘CTR’) prepared by the AIF manager includes compliance with all chapters of this Master Circular. This CTR must be submitted within 30 days following the end of the financial year. If the AIF is structured as a trust, the CTR should be submitted to both the trustee and the sponsor. If the AIF is established in a form other than a trust, the CTR should be submitted to the sponsor. This process ensures regulatory compliance and transparency within the AIF sector.
O. Investor charter and grievance redressal
Ch. XVII includes an Investor Charter detailing services, grievance redressal mechanisms, and investor responsibilities in AIFs. Additionally, AIFs must disclose data on investor complaints and their redressal status separately in the Private Placement Memorandum (PPM). These requirements aim to enhance transparency and investor protection within AIFs.
P. Other provisions
Ch. XIV includes provisions regarding the manager's constitution of an Investment Committee to approve the AIF's decisions, subject to certain conditions. The manager is required to furnish a waiver to the AIF regarding compliance with the responsibilities of Investment Committee members.
Ch. XVI mandates performance benchmarking for AIFs to help investors compare them with other investments. AIFs must report scheme-wise valuation and cash flow data to Benchmarking Agencies, which will generate performance reports. Customised reports, except Angel Funds under Category I - AIF, can also be requested.
Ch. XVIII requires AIFs to comply with the Indian Stamp Act, 1899, for stamp duty on the sale, transfer, and issuance of units. RTAs will collect the duty for non-demat transactions, while recognised stock exchanges and depositories handle demat transactions.
Ch. XIX mandates SEBI approval and a fee for changes in the control of AIF sponsors or managers. Exceptions include manager replacements and exits of multiple sponsors. Changes needing NCLT approval must first be submitted to SEBI.
Ch. XX requires all AIF units to be issued in dematerialised form by specified deadlines based on fund size. Units for investors without demat accounts will be held in an Aggregate Escrow Demat Account until details are provided, and records must be maintained and reported monthly.
Ch. XXII mentions Valuation and Reporting. SEBI mandates timely and accurate valuation reporting to performance benchmarking agencies for AIF managers and specifies requirements for investee company audits and compliance reporting.
Ch. XXIII mentions guidelines for launching liquidation schemes during the liquidation period, including investor consent, bid arrangements, dissenting investor options, and in-specie distributions.
Ch. XXIV mentions criteria for excusing or excluding investors from specific investments, including legal compliance, internal policy considerations and documentation requirements.
Ch. XV includes specifications for Direct Plans in AIF schemes without distribution fees and guidelines for disclosing and charging distribution fees, including upfront and trial models based on the AIF category.
Conclusion
In conclusion, the issuance of the comprehensive Master Circular by the SEBI marks a significant milestone in the regulation of AIFs. The SEBI aims to enhance transparency, accountability, and investor protection within the alternative investment sector by consolidating and updating the regulatory framework.
The Master Circular encompasses a wide range of provisions, covering areas such as registration requirements, standardised templates for PPMs, investment guidelines, operational norms, and compliance reporting. It also clarifies the obligations of managers, sponsors, and trustees of AIFs, emphasising the importance of ethical conduct, regulatory compliance, and investor-centric practices.
End Note
[i] SEBI/HO/AFD-1/AFD-1-PoD/P/CIR/2024/39 dated 07.05.2024 SEBI/HO/MIRSD/MIRSD-PoD-1/P/CIR/2024/49 dated 21.05.2024.
Authored by Shreya Manchanda, Advocate at Metalegal Advocates. The views expressed are personal and do not constitute legal opinion.
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