BMR AIF Guidelines

8/11/2019 BMR AIF Guidelines

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Vol. 6 Issue 5.1 May 28, 2012

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The AIF Regulations notif ied Impact on the PE industry

The Securities and Exchange Board of India (SEBI) has notified the SEBI (Alternative

Investment Funds) Regulations, 2012 (AIF Regulations) on May 21, 2012. The SEBI

had earlier issued a concept paper on August 1, 2011, discussing the proposed

introduction of the AIF Regulations and invited public comments. The new AIF

Regulations have been rationalized on many aspects, taking into account the industry

concerns and representations. The central theme seems to be to offer concessions

only to select venture capital funds, to encourage investment in early stage, technology

ventures and innovation focused companies. Opening up new categories such as debt

funds, hedge funds and fund of funds will pave the way for the reforms in the regulation

of the alternative investment asset class in India.

The key highlights of the AIF Regulations are summarized below:

Alt ernative Investment Fund

An Alternative Investment Fund (AIF) has been defined to mean any fund established

or incorporated in India in the form of a trust or a company or a limited liability

partnership (LLP) or a body corporate which (i) is a privately pooled investment vehicle

and (ii) is not covered under the SEBI (Mutual Funds) Regulations, 1996, SEBI

(Collective Investment Schemes) Regulations, 1999 or any other regulations of the

SEBI to regulate fund management activities.

The AIF Regulations specifically exclude family trusts, ESOP trusts, employee welfare

trusts / gratuity trusts, holding companies (as defined in the Companies Act, 1956),

special purpose vehicles (not established by fund managers), funds managed by

securitization company or reconstruction company or any such pool of funds which isdirectly regulated by any other regulator in India.

Classification of AIFs

Based on the investment objectives sought to be achieved, AIFs are classified into the

following three broad categories:

1. Category I AIF:

Funds which invest in start-ups, early stage ventures, social ventures,

infrastructure or other sectors which the government or regulators consider as

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socially or economically desirable will qualify as Category I AIFs. These funds

are generally perceived to have positive spillover effects on the economy and for

which the SEBI or the Government might consider providing incentives or

concessions. This category includes Venture capital funds (VCFs), SME funds,

social venture funds, infrastructure funds and such other AIFs as may be

prescribed

VCF: AIF which invests primarily in unlisted securities of start-ups,

emerging or early stage venture capital undertakings [defined along thesame lines as under the SEBI (VCF) Regulations, 1996 (VCF

Regulations)] mainly involved in new products, new services, technology or

intellectual property right based activities or a new business model.

SME fund: AIF which invests primarily in unlisted securities of SMEs which

are listed or proposed to be listed on a SME exchange or SME segment of

an exchange.

Social venture fund: AIF which invests primarily in securities or units of

social ventures and which satisfies social performance norms laid down by

the fund and whose investors may agree to receive restricted or mutedreturns.

Infrastructure fund: AIF which invests primarily in unlisted securities or

partnership interest or listed debt or securitized debt instruments of

investee companies or special purpose vehicles engaged in or formed for

the purpose of operating, developing or holding infrastructure projects.

2. Category II AIF:

These are the fundswhich do not fall under Category I and Category III and

which do not undertake leverage or borrowing other than to meet day to day

operational requirements. No specific incentives or concessions will be givenby the Government to Category II AIFs

This category includes private equity funds and debt funds

3. Category III AIF:

These are the funds which employ diverse or complex trading strategies and

may employ leverage including through investment in listed or unlisted

derivatives. No specific incentives or concessions will be given by the

Government to Category III AIFs

This category includes hedge funds or funds which trade with a view to makeshort term returns or such other funds which are open ended

Registration

1. All AIFs are required to seek registration in any one of the above mentioned

categories and in case of Category I AIF, in any one of the sub-categories.

Category under which registration is granted can be changed only with prior

approval of the SEBI.

2. The AIF Regulations permit the launch of multiple schemes without separate

registration from SEBI subject to filing of Placement Memorandum for the relevant

Bobby Parikh, Mumbai+91 22 3021 7010

[email protected]

Shefali Goradia, Mumbai+91 22 3021 [email protected]

Russell Gaitonde, Mumbai+91 22 3021 [email protected]


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scheme with the SEBI 30 days prior to launch of the scheme along with the

prescribed fees.

3. The key eligibility criteria for seeking registration as an AIF is summarized below:

The constitution documents of the applicant must permit it to carry on the

activity of an AIF and must contain a restriction to make an invitation to the

public to subscribe to its securities

The applicant at the time of registration must disclose its investment objective,

the targeted investors, proposed corpus, investment style or strategy and

proposed tenure of the fund or scheme

The minimum corpus of the AIF must be INR 200 million

Minimum investment amount by any investor must be INR 10 million; threshold

for employees or directors of AIF reduced to INR 2.5 million

No scheme of any AIF must have more than 1,000 investors

Category I and Category II AIFs must have a minimum tenure of 3 years and

must be close ended. However Category III AIFs do not have any such

stipulation

The applicant, its Sponsor and Manager must be fit and proper persons as

defined in the SEBI (Intermediaries) Regulations, 2008

The key investment team of the Manager of the applicant must have adequate

skill and experience as prescribed under the AIF Regulations and one of the

key investment team personnel must have five years relevant track record

Sponsor and Manager must have necessary infrastructure and manpower to

effectively discharge their obligations

The Manager or Sponsor must have continuing investment in the AIF of not

less than the lower of 2.5 percent of the corpus or INR 50 million and such

investment must not be made by way of waiver of management fees. In case

of Category III AIFs, the corresponding limits are 5 percent and INR 10 million

respectively. The Manager and Sponsor investments must be disclosed to the

investors of the AIF

Co-investment, if any, by Manager or Sponsor of the AIF in an investee

company must not be on terms more favourable than those offered to AIF

Investment conditions and restrictions

General investment conditions

1. Category I and Category II AIFs must not invest more than 25 percent of the corpus

in any one investee company. The corresponding limit is 10 percent for a Category

III AIF.

2. AIFs must not invest in associates except with prior approval of 75 percent of

investors by value. The term associates has been defined in the AIF Regulations

and is broadly in line with the VCF Regulations.


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3. AIFs may invest in securities of foreign companies subject to the prescribed

conditions.

4. AIFs may also invest in LLPs.

5. AIFs are permitted to invest their un-invested corpus in liquid mutual funds or bank

deposits or other liquid assets of higher quality such as treasury bills, CBLOs,

Commercial Papers, and Certificates of Deposits etc till the deployment of funds

as per the investment objective.

6. All AIFs qualify as qualified institutional buyers and may also act as a Nominated

Investor as specified under the SEBI (Issue of Capital and Disclosure

Requirements) Regulations, 2009 for issues on the SME exchange.

Other category specific investment conditions

With respect to leveraging / hedging

1. Category I and Category II AIFs are not permitted to borrow funds directly or

indirectly or engage in any leverage except for meeting temporary funding

requirements for not more than 30 days. Such instances of leveraging can be

undertaken to a maximum of four times a year and cannot exceed 10 percent of the

corpus of the AIF. Category II AIFs may also engage in hedging subject to

guidelines issued by the SEBI.

2. Category III AIFs may engage in leverage or borrow subject to consent from the

investors in the fund and subject to a maximum limit as may be specified by the

SEBI.

With respect to investments in other AIFs

1. Category I AIFs are permitted to invest in units of Category I AIFs of same sub-

category. They are not permitted to invest in other fund of funds.

2. Category II and Category III AIFs are permitted to invest in units of Category I

and Category II AIFs. They are not permitted to invest in other fund of funds.

Transition provision for existing funds

With respect to unregistered funds

Un-registered funds which are not registered under the VCF Regulations or any

other regulations and which fall within the definition of an AIF, may seek

registration under AIF Regulations within six months or discontinue operations

after a period of six months. In special cases, SEBI can extend the period upto 12

months

The existing schemes of such funds will be allowed to complete their agreed tenure

provided they do not raise any fresh monies other than commitments already

received till the registration under the AIF Regulations is granted

In case the unregistered funds are unable to comply with the conditions prescribed

under the AIF Regulations, the SEBI may on examination of the facts, issue certain

exemptions

With respect t o VCFs registered under VCF Regulations


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The funds registered as VCFs will continue to be regulated by the VCF Regulations

till the existing fund or scheme managed by the fund is wound up

Such funds are not permitted to launch any new scheme or raise any capital

commitments beyond the original targeted corpus unless they seek registration

under AIF Regulations

The VCFs registered with the SEBI are permitted to seek re-registration under the

AIF Regulations subject to approval of 2/3rdof their investors by value of their

investment

BMR Comments

The AIF Regulations endeavor to extend the perimeter of regulation to unregulated

funds with a view to providing stability, increasing market efficiency and encouraging

formation of new capital and consumer protection. The AIF Regulations also

broaden the investment horizon for AIFs to debt and other complex products, which

is a progressive move. All the concessions that were hitherto available to VCFs

have now been extended to Category I AIF and select investments by Category II

AIF. Simultaneously, the SEBI has amended the SEBI (Foreign Venture Capital

Investors) Regulations (FVCI Regulations) to restrict investment by FVCIs only in

the existing VCFs and in funds registered as VCFs under Category I AIF. Given

this, unified funds in other categories will be possible only if FDI policy permits such

investment.

Key positives

Grandfathering of existing VCFs such that these are permitted to raise

additional capital commitment within the original targeted corpus is a welcome

relief

Introduction of debt funds, hedge funds, fund of funds will permit fund

managers to broaden the investment horizons

Rationalization of the Managers commitment to the fund is a welcome move.

Further, the removal of the requirement to buyout the investments at the time

of winding down of the AIF is a significant relief to the Sponsors and Managers

Category I and Category II AIFs are exempt from SEBI Insider Trading

Regulations in respect of investments in companies listed on SME Exchange

or SME segment of an exchange

AIFs can be incorporated as LLPs; similarly AIFs are permitted to invest in

LLPs - this would add to the popularity of LLPs as an investment vehicle

Key challenges

Challenges for all AIFs

While multiple schemes will be allowed to be launched under any AIF, each

scheme must operate under the same category of AIF


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The AIF Regulations impose onerous reporting obligations and also include

regulations on several commercial matters which hitherto were subject matter

of negotiations between the investors and the Sponsor and / or the Manager

While the requirement to appoint custodians is better from investor protection

perspective, it will increase costs for the AIFs

Challenges for Category II and Category III AIFs (including PE Funds)

Restriction on FVCIs to invest only in the existing VCFs and in funds registered

as VCFs under Category I will deter India based fund managers from setting

up unified structures; however, FDI route may be available if FDI policy is

suitably clarified / amended

Tax pass through is restricted to only Category I AIFs and is not extended to

other categories of AIFs. While the other AIFs set up as trusts should still

enjoy tax pass through, this will create some uncertainty

Exemption from lock-in post listing of investee companies will be available only

to Category I AIFs apart from the existing VCFs

Similarly, the exemption from triggering open offer under the SEBI Takeover

Code is extended only to cases where shares in the target are purchased by

promoters from Category I AIFs

Disclaimer:

This newsletter has been prepared for clients and Firm personnel only. I t provides general information and guidance as on date of preparation

and does not express views or expert opinions of BMR Advisors. The newsletter is meant for general guidance and no responsibility for lossarising to any person acting or refraining from acting as a result of any material contained in this newsletter will be accepted by BMR Advisors.It is recommended that professional advice be sought based on the specific facts and circumstances. This newsletter does not substitute theneed to refer to the original pronouncements.

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