ALTERNATIVE INVESTMENT FUNDS – PART I.

[Mr. M. GOVINDARAJAN]

                        Securities Exchange Board of India (‘SEBI’ for short) made the ‘Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 which came into effect from 21.05.2012.

ALTERNATIVE INVESTMENT FUND:

                        Regulation 2(b) defines the terms ‘Alternative Investment Funds’ 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 which-

• 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
• is not covered under the SEBI (Mutual Funds) Regulations, 1996, SEBI (Collective Investment Schemes) Regulations, 1999 or any other regulations of the Board to regulate fund management activities.

The following shall not be considered as alternative investment fund:

• family trusts set up for the benefit of ‘relatives’ as defined under Companies Act, 1956;
• ESOP Trusts set up under the SEBI (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 securitization 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 or funds which is directly regulated by any other regulation in India.

CATEGORIES OF ALTERNATIVE INVESTMENT FUND:

There are three categories of alternative investment fund, namely, Category I Alternative Investment Fund, Category II Alternative Investment Fund and Category III Alternative Investment Fund.

                        Category I alternative investment fund which invests in start-up or early stage of ventures or social ventures or SMEs or infrastructure or other sectors or areas which the government or regulators consider as socially or economically desirable and shall include venture capital funds, SME  funds, social venture funds, infrastructure funds and such other alternative investments as may be specified. 

                        Social Venture is defined under Regulation 2(u) as a trust, society or company or venture capital undertaking or limited liability partnership formed with the purpose of promoting social welfare or solving social problems or providing social benefits and includes-

• public charitable trusts registered with Charity Commissioner;
• societies registered for charitable purposes or for promotion of science, literature or fine arts;
• company registered under Section 25 of the Companies Act, 1956;
• micro finance institutions.

‘Social Venture Fund’ is defined under Regulation 2(v)  as an alternative investment fund 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 muted returns.

                        ‘Venture Capital fund’ is defined under Regulation 2(z)  as an alternative investment fund which invests primarily in unlisted securities of start-ups, emerging or early stage venture capital undertakings mainly involved in new products, new services, technology or intellectual property right based  activities or a new business model.    ‘Venture Capital undertaking’ is defined under Regulation 2(aa) as a domestic company which is not listed on a recognized stock exchange in India at the time of making investment and which is engaged in the business for providing services, production or manufacture of article or things and does not include following activities or sectors:

-          non banking financial companies;

-          gold financing;

-          activities not permitted under industrial policy of Government of India;

-          any other activity which may be specified by the SEBI in consultation with Government of India from time to time.

Category II alternative investment fund which does not fall in Categories I and III and which does not undertake leverage or borrowing other than to meet day-to-day operational requirements and as permitted in these regulations.  Alternative funds such as private equity funds or debt funds for which no specific incentives or concessions given by the government or any other regulator shall be included.

                        Category III alternative investment fund which employs diverse or complex trading strategies  and may employ leverage including through investment in listed or unlisted derivatives.  Alternative investment funds such as hedge funds or funds which trade with a view to make short term returns or such other funds which are open ended and for which no specific incentives or concessions are given by the government or any other regulator shall be included.  taxmanagementindia.com

CONDITIONS FOR ALTERNATIVE INVESTMENT FUNDS:

Category I:

• This fund shall invest in investee companies or venture capital undertaking or in special purpose vehicles or in limited liability partnerships or in units of other alternative investment funds as specified in the regulations.  This fund may invest in units of Category I alternative investment funds of same category.   They shall only invest in such units and shall not invest in units of other fund of funds. 

Category II:

• These funds shall invest primarily in unlisted investee companies or in units of other alternative investment funds as may be specified in placement memorandum;
• These funds may invest in units of Category I or Category II alternative investment funds.  They shall only invest in such units and shall not invest in units of other fund of funds;
• These funds may not borrow funds directly or indirectly and shall not engage in leverage except for meeting temporary funding requirements for not more than 30 days, not more than four occasions in a year and not more than 10% of the corpus;
• These funds may engage in hedging subject to guidelines as specified by the Board from time to time;
• These funds may enter into agreement with merchant banker to subscribe to the unsubscribed portion of the issue or to receive or deliver securities in the process of market making   under Chapter XB of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009;
• These funds shall be exempt from regulations 3 and 3A of SEBI (Prohibition of Insider Trading) Regulations, 1992 in respect of investment in companies  listed on SME exchanges or SME segment of an exchange pursuant to due diligence  of such companies subject to the following conditions:
  • The fund shall disclose any acquisition or dealing in securities pursuant to such due diligence, within two working days of the acquisition or dealing, to the stock exchanges where the investee company is listed;
  • Such investment shall be locked in for a period of one year from the date of investment.

Category III:

• These funds may invest in securities of listed or unlisted investee companies or derivatives or complex or structured products;
• These funds may invest in units of Category I or Category II alternative investment funds.  For this they should invest solely in such units and shall not invest in  units of any other fund of funds;
• These funds may engage in leverage or borrow subject to consent from the investors in the fund and subject to maximum limit, as may be specified by the Board. Such funds shall disclose information regarding the overall level of leverage employed, the level of leverage arising from borrowing of cash, the level of leverage arising from position held in derivatives or in any complex product and the main source of leverage in their fund to the investors and to the Board periodically, as may be specified by the Board. 
• These funds shall be regulated through issuance of directions regarding areas such as operational standards, conduct of business rules, prudential requirements, restrictions on redemption and conflict of interest as may be specified by the Board.

TENURE:

v  Category I fund and Category II fund shall be close ended and the tenure of fund or scheme shall be determined at the time of application such fund or schemes shall have a minimum tenure of three years;

v  Category III fund may be open ended or close ended.

v  Extension of the tenure of the close ended alternative investment fund may be permitted up to 2 years subject to approval of two thirds of the unit holders by value of their investment in the alternative investment fund

v  In the absence of consent of unit holders, the alternative investment fund shall fully liquidate within one year following expiration of the fund tenure of  extended tenure.

The registration procedure, general obligation and responsibilities and transparency, disputes resolution, winding up, inspection etc., will be discussed in Part II of this article.