SEBI AIF Regulations 2012

SEBI (Alternative Investment Funds)
Regulations 2012:
Opens gates for hedge funds, real estate
fund and other collective funds in India

Aditi Jhunjhunwala
Nidhi Ladha
aditi@vinodkothari.com
nidhiladha@vinodkothari.com
Vinod Kothari & Company
May 23, 2012

Analytical Speaking

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SEBI AIF Regulations opens gates for hedge funds, real estate funds in India

Analytical Speaking

VKC

In order to create distinct private pooled investment vehicles to concessionalise
VCFs, SME Funds, Social Venture Funds and other funds collecting money from
investors which were not regulated by any of the SEBI Regulations, SEBI came out
with the concept paper on Alternative Investment Funds Regulation on August 01,
2011. The concept paper was accompanied by a draft set of regulations: SEBI (AIF)
Regulations, 2011 [the draft Regulations]. It was observed that VCFs were being
used as an omnibus investment fund which leaves most of the private investment
funds dissatisfied, hence a need for comprehensive regulation was felt. Registration
under VCF Regulations was not mandatory in nature, hence, many unregistered
funds were in existence.

Through the concept paper, SEBI proposed to regulate all funds established in India
which are private pooled investment vehicles raising funds from Indian or foreign
investors, excluding Mutual Funds and Collective Investment Schemes registered
with SEBI. Further, any such pool of funds which is regulated by any other regulator
in India like banks, pension funds, etc. were proposed to be excluded from the
purview of the draft Regulations.

Finally, in its meeting held last month, SEBI approved the regulations and on May
21, 2012, notified the SEBI (Alternative Investment Funds) Regulations, 2012 [the
AIF Regulations]. The final framework constitutes lot of changes as suggested by
the industry after the draft Regulations were released for comments.
Highlights
The AIF Regulations require mandatory registration of an AIF whether it be a
company or an LLP or a trust or any other body corporate pooling interest
from investors;
Applicable to all pooled investment vehicles other than Mutual Funds, CIS
Schemes, Family Trusts, ESOP Trusts, Employee Welfare Trusts, holding
companies, funds managed by Asset Reconstruction Companies,
Securitisation Trust or any such pool of funds which is directly regulated by
any other regulator in India;


Analytical Speaking

VKC
Three categories of registrations have been prescribed based on risk profiles
of the AIFs;
An application of registration by the funds may be rejected by SEBI and
intimation to the applicant is to be given within 30 days;
SEBI (Venture Capital Fund) Regulations, 1996 [VCF Regulations] have
been repealed however, existing VCFs are to be regulated by the VCFs
Regulations till the existing fund or scheme managed by the fund is wound
up;
Existing VCFs can seek re-registration under the AIF Regulations subject to
approval of 2/3rd (66.67 per cent) of investors by value;
A minimum Corpus of Rs. 20 crores have been prescribed for each scheme of
the AIFs;
Minimum investment to be accepted by AIFs from a single investor is Rs 1
crore;
An AIF can have a maximum of 1000 investors and not more than that;
An Alternative Investment Fund which has been granted registration under a
particular category cannot change its category subsequent to registration,
except with the approval of the SEBI;
An application fee of Rs. 1 lac and registration fee of Rs. 5 lac is to be
accompanied with the Registration Application;
A Scheme Fee of Rs 1 lac is to also required to be paid on launching a new
scheme except the first scheme;
Analysis of the AIF Regulations:
Scope of the Regulation

All AIFs are mandatorily required to get themselves with SEBI as per the
Regulations. As the AIF Regulations extend to AIFs, so the most important question
is which all funds are to be treated as AIFs and require registration.

Regulation 2 (1) (b) defines Alternative Investment Fund as:

Alternate Investment Fund means any fund established or incorporated in India in
the form of a trust or a company or a limited liability partnership or a body
corporate which,-

Analytical Speaking

VKC

(i) is a privately pooled investment vehicle which collects funds from investors,
whether Indian or foreign, for investing it in accordance with a defined investment
policy for the benefit of its investors; and
(ii) is not covered under the Securities and Exchange Board of India (Mutual
Funds) Regulations, 1996, Securities and Exchange Board of India (Collective
Investment Schemes) Regulations, 1999 or any other regulations of the Board to
regulate fund management activities

Further, by way of a proviso to the above definition, the following have been kept
out of the purview of the definition of AIF:

Family trusts set up for the benefit of relatives as defined under Companies
Act, 1956;
ESOP Trusts set up under the Securities and Exchange Board of India
(Employee Stock Option Scheme and Employee Stock Purchase Scheme),
Guidelines, 1999 or as permitted under Companies Act, 1956;
Employee welfare trusts or gratuity trusts set up for the benefit of
employees;
Holding Companies within the meaning of Section 4 of the Companies Act,
1956;
Other special purpose vehicles not established by fund managers, including
securitization trusts, regulated under a specific regulatory framework;
Funds managed by securitisation company or reconstruction company which
is registered with the Reserve Bank of India under Section 3 of the
Securitisation and Reconstruction of Financial Assets and Enforcement of
Security Interest Act, 2002; and
Any such pool of funds which is directly regulated by any other regulator in
India.

Analysis of the definition: What should be the constituents of an AIF?

The following features can be derived from the definition of AIF mentioned above:

An AIF can be set up as a company or LLP or trust or a body corporate model.

Analytical Speaking

VKC
The fund should be a private fund engaged in pooling investments from
investors. A public fund in the same business is not covered by the
Regulations.
o SEBI vide these Regulations, has made the scope of the word private
very liberal and wider. Regulation 10(f) restricts a maximum number
of investor in AIF to 1000. Hence, a private fund shall be having a
large base of investors which may go up to a thousand.
Another feature of AIF is that it should be pooling investments. The simple
meaning of pooling is collecting money from a group of investors to invest
further for a mutual benefit. So, any fund raising money privately for further
investment can be treated as AIF subject to fulfillment of other conditions.
Funds should be an investment vehicle. Funds to be passively engaged in
investments in prescribed areas/companies. In other words, persons putting
in money in the fund do not get management rights in investee and do not
participate actively in day to day affairs of the investee.
It should not be a mutual fund registered under SEBI (Mutual Fund)
Regulations, 1996.
It should not be registered under SEBI (Collective Investment Schemes)
Regulations, 1999.
It is not regulated by any other SEBI regulations regulating fund
management activities.
Exception provided in proviso (v) carves out another important feature of
the Fund. The exception applies to all SPVs not regulated by fund managers
and are regulated by specific regulatory framework. In other way round, a
fund managing its investments regularly i.e. a fund engaged in regular buying
and selling of investments shall be treated as an AIF. Fund management,
thus, becomes another characteristic of an AIF.
Territorial scope of the Regulations
The definition of AIFs under Regulation 2 (1) (b) starts as any fund established or
incorporated in India in the form of a trust or a company or a limited liability
partnership or a body corporate .

Further, Regulation 2(1)(o) defines an investee company as:

any company, special purpose vehicle or limited liability partnership or body
corporate in which an Alternative Investment Fund makes an investment

Analytical Speaking

VKC

As a body corporate includes a company registered outside India, a careful reading
of both the definitions extracted above clarifies that the scope of these Regulations
extends to:

Funds established in India and investing in India;
Funds established in India and investing abroad;
Funds established abroad and investing in India.

Thus, even a foreign fund established in India and fulfilling the conditions of the
AIFs would require compliance under the Regulations. An AIF established or
incorporated in India, whether Indian or a foreign body corporate, require
registration if it is carrying out business in India. An entity registered outside India
and executing business outside India is not required to get itself registered under
these Regulations.
Registration Requirement
Regulation 3 prescribes the registration requirement of AIFs. As the registration is
mandatory, AIFs shall not be allowed to carry on its business without obtaining a
certificate of registration in terms of this Regulation. In nutshell:

An AIF to compulsorily obtain certificate of registration from SEBI.
In case of an existing unregistered fund falling within the definition of AIF,
the fund may continue to operate only for a period of six months from the
date of these Regulations or where it has applied for registration within such
period of six months, till disposal of the application.
o SEBI may extend such period of six months to twelve months in some
special cases.
Existing schemes of existing unregistered funds will be allowed to complete
their agreed tenure.
Till registration is granted, the unregistered funds shall not be allowed to
raise further fund other than commitments already made.
Relaxation from any or all of the requirements of these Regulations may be
granted by SEBI to the existing funds on application for exemption.
Registered Venture Capital Funds [VCFs] can continue to be regulated under
VCF Regulations until the existing fund or the scheme managed by such fund
is wound up.

Analytical Speaking

VKC
o No new scheme to be launched by such funds after issue of the AIF
Regulations.
o The existing fund or scheme shall not be allowed to increase the
targeted corpus of the fund or scheme after notification of these
regulations.
It is pertinent to note here that corpus has been defined in the
AIF Regulations as total amount of committed funds by the
investors by way of a written contract or any such document
as on a particular date. A clear explanation in this regard leaves
a way out and it can be interpreted that funds may be raised as
per the verbal commitments even after existence of the AIF
Regulations.
o VCFs may seek re-registration under the AIF Regulations subject to
approval of two-thirds of their investors by value of their investment.
Registrations to be granted category wise
SEBI, after receiving comments on the draft Regulations, notified following
categories of AIFs requiring registrations:

Category I Alternative Investment Fund
o invests in start-up or early stage ventures or social ventures or SMEs
or infrastructure or other sectors or areas which the government or
regulators consider as socially or economically desirable
Includes venture capital funds, SME Funds, social venture
funds, infrastructure funds.

Category II Alternative Investment Fund
o which does not fall in Category I and III and which does not undertake
leverage or borrowing other than to meet day-to-day operational
requirements
Such funds are intended to do business with the corpus only
and will not be borrowing funds.

Category III Alternative Investment Fund
o Funds which employ diverse or complex trading strategies and may
employ leverage including through investment in listed or unlisted
derivatives

Analytical Speaking

VKC
Hedge funds, fund of fund, real estate funds are typical
examples.
Regulations are more stringent for this category. Directions
regarding areas such as operational standards, conduct of
business rules, prudential requirements, restrictions on
redemption and conflict of interest are to be issued by SEBI
soon.
Eligibility Conditions
The conditions for eligibility of AIFs have been detailed in Regulation 4. Different
eligibility criteria for different forms (LLP, Company, Trust or a body corporate) of
funds have been prescribed.

Further, the Regulations also prescribe eligibility criteria for the sponsor or
manager of the AIF. The sponsor or manager is required to have a continuing
interest in the AIFs of not less than two and half percent of the corpus or five crore
rupees, whichever is lower, in the form of investment in the AIFs and such interest
shall not be through the waiver of management fees. A continuing interest of five
percent or ten crores rupees has been prescribed for Category III AIFs.

Thus, any applicant has to ensure that it meets the eligibility criteria laid down and
also satisfies the definition of Alternative Investment Fund as provided in the
Regulations for seeking registration. SEBI may refuse registration, if not satisfied, by
giving the applicant an opportunity of being heard and such intimation of rejection
is to be conveyed to the applicant within 30 days from taking such decision. It has
further been clarified in Regulation 8(3) that once an application is rejected, the
applicant shall cease to carry on any activity as an AIF. However, any liability of the
applicant towards its existing investors under law or agreement shall not be
affected in any way.
Pooling of investments by AIFs

Instead of adopting a specific approach depending on the type of applicant, the
Regulations have laid down blanket investment conditions whereby all categories of
AIFs would be subject to certain conditions, the chief being enumerated below:


Analytical Speaking

VKC
Funds may be raised from resident Indians as well as foreign investors and non
resident Indians;
o It is important to point out here that eligible investors under FEMA
Regulations include VCFs but do not include the AIFs, hence, requiring
immediate amendment to this effect.
Each scheme of the AIF shall have corpus of atleast twenty crore rupees;
Minimum investment to be accepted by an investor is one crore rupees;
o The directors and the employees of the AIFs and/or managers have
been kept out of the purview of the above limit and minimum
investment amount for them is twenty five lakh rupees.
The Manager or Sponsor shall have a continuing interest in the AIF up to the
specified limit and shall disclose their investment in the fund to the investors of
the AIF;
A maximum of 1000 investors can invest in an AIF.
Funds to be raised on private placement basis.
Procedure for raising funds
As mentioned above, an AIF can raise funds from a maximum of 1000 investors only
by allotting its units issued under various schemes. Before raising any fund from
such investors by launching a scheme, the AIF is required to file a placement or
information memorandum, along with the prescribed fee, with SEBI at least 30 days
prior to launch of the scheme giving detailed and material information about the AIF
and the manager for comments of SEBI, if any.

However, no such fee is to be paid on filing of memorandum for launch of first
scheme by the AIF.

The procedure of filing an information memorandum before raising funds is
somewhat similar to that prescribed for public offers by companies.
Tenure of an AIF
Category I and Category II AIFs
o Close ended and the tenure of fund or scheme shall be determined at
the time of application subject to sub-regulation (2) of this Regulation
o Schemes launched by such funds shall have a minimum tenure of
three years.
o Buy-back not allowed as close-ended in nature.

Analytical Speaking

VKC
o Such AIFs may get themselves listed on a stock exchange after closure
of the fund/scheme.
Category III Alternative Investment Fund may be open ended or close ended.
o Close ended funds may apply for listing.
o Open ended funds can buy-back the units issued
Extension of the tenure of the close ended AIF may be permitted up to a
further two years subject to approval of two-thirds of the unit holders by
value of their investment
o In absence of any extension/further extension, the AIF is to fully
liquidate within one year following expiration of the fund tenure or
extended tenure
Where an AIF can invest?
All AIFs are to decide in advance the investment strategy for the pooled fund and
same is to be mentioned in the Placement Memorandum at the time of launching a
scheme. Any material alteration to the fund strategy is allowed only with the
consent of atleast two-thirds of unit holders by value of their investment in the AIF.
An AIF is allowed to invest in following:

In securities of companies incorporated outside India subject to such conditions
as may be prescribed by SEBI and RBI;
Co-investment in an investee company by a Manager or Sponsor shall not be on
terms more favourable than those offered to the AIF;
Category I and II AIFs are not allowed to invest not more than twenty five
percent of the corpus in one Investee Company;
o Investee company includes an LLP, meaning an AIF can invest in LLPs
too.
Category III AIF are allowed to invest up to ten percent of the corpus in one
Investee Company;
AIFs are allowed to invest in associates subject to approval of seventy five
percent of investors;
Un-invested portion of the corpus may be invested in liquid mutual funds or
bank deposits or other liquid assets of higher quality such as Treasury bills,
CBLOs, Commercial Papers, Certificates of Deposits, etc. till deployment of funds
as per the investment objective;


Analytical Speaking

VKC
Further category wise investment conditions have been prescribed by the
Regulations.
Investment conditions for Category 1
Category 1 AIFs are allowed to invest in SPVs, LLPs, investee companies,
venture capital undertakings and even in units of other AIFs of category 1.
The AIFs in this category are not allowed to borrow funds directly or indirectly
or engage in any leverage except for meeting temporary funding requirements
for not more than thirty days, on not more than four occasions in a year and not
more than ten percent of the corpus.
Additional conditions have been prescribed for VCFs under this category:
o The same were previously there in the VCF Regulations.
o Investments in SME segment (in listed or proposed to be listed SME
companies) have been permitted by the new Regulations which were not
allowed earlier.
o Limited investment through qualified institutional placement in
preferential allotment is allowed in equity linked instruments of listed
entities
Additional conditions provided for SME Funds:
o Atleast seventy five percent of the corpus shall be invested in unlisted
securities or partnership interest of venture capital undertakings or
investee companies which are SMEs or in companies listed or proposed
to be listed on SME exchange or SME segment of an exchange
Additional condition for Social Welfare Funds include:
securities or partnership interest of social ventures
o Such funds may accept grants, provided that such utilization of such
grants shall be restricted to clause mentioned above
Additional conditions for Infrastructure Funds:
securities or units or partnership interest of venture capital undertaking
or investee companies or special purpose vehicles, which are engaged in
or formed for infrastructure projects
o These funds may also invest in listed securitized debt instruments or
listed debt securities of investee companies or special purpose vehicles,
engaged in infrastructure projects

Analytical Speaking

VKC
Conditions for Category II AIFs
These shall primarily invest in unlisted investee companies or in units of other
AIFs of Category I and II.
May not borrow funds directly or indirectly and shall not engage in leverage
except for meeting temporary funding requirements for not more than thirty
days, not more than four occasions in a year and not more than ten percent of
the corpus.
Category II AIFs may engage in hedging, subject to guidelines as specified by
SEBI
Conditions for Category III AIFs
These AIFs may invest in securities of listed or unlisted investee companies or
derivatives or complex or structured products and in units of other AIFs of
Category I and II.
Such AOFs 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
SEBI
Valuation of AIFs
Category I and Category II Alternative Investment Funds shall undertake valuation
of their investments, atleast once in every six months, by an independent valuer.
However, such period may be enhanced to one year on approval of atleast seventy-five
percent of the investors.

Category III AIFs shall calculate net asset value (NAV) independent from the fund
management function of the AIF and such NAV shall be disclosed to the investors at
intervals not longer than a quarter for close ended Funds and at intervals not longer
than a month for open ended funds.
Conclusion

The Regulations permit a hedge fund, a real estate fund (REIT) to carry out business
in India after registration with SEBI. Previously, REITs were not identified in India
one of the difficulty being double tax implications. However, as LLPs can be formed
as an AIF, hence business of REITs may be effectively carried out by an LLP model as
taxability is only in hands of partners.


Analytical Speaking

VKC
The new Regulations posses several features like investment strategy, disclosure of
periodic information to investors, valuation procedure, audit of fund, dispute
resolution, winding up of funds etc. These comprehensive Regulations would surely
bring greater clarity to the market and the investors and its all-encompassing
nature will bring several investment entities that were hitherto unregulated by
SEBI. This constitutes a drastic change and will require investors to adapt
themselves to a new and transparent regulatory regime.

This change in the regime of funds will also require amendment to exchange control
laws, FDI norms and various SEBI Regulations which are yet to be notified.

SEBI AIF Regulations 2012

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