Alternative Investment Funds (AIFs)
Anything alternate to traditional form of investments gets categorized as alternative investments. Now, what is considered as traditional may vary from country to country. Generally, investments in stocks or bonds or fixed deposits or real estates are considered as traditional investments. However, even with respect to investments in stocks, if the investments are in the stocks of small and medium scale enterprises (SMEs), it gets categorized as alternative investments in many jurisdictions (For instance, the SME exchange is called as Alternative Investment Market (AIM) in UK). Generally, the term AIF refers to private equity and hedge funds.
In India, alternative investment funds (AIFs) are defined in Regulation 2(1)(b) of Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012. It refers to any privately pooled investment fund, (whether from Indian or foreign sources), in the form of a trust or a company or a body corporate or a Limited Liability Partnership(LLP) which are not presently covered by any Regulation of SEBI governing fund management (like, Regulations governing Mutual Fund or Collective Investment Scheme)nor coming under the direct regulation of any other sectoral regulators in India-IRDA, PFRDA, RBI. Hence, in India, AIFs are private funds which are otherwise not coming under the jurisdiction of any regulatory agency in India.
Thus, the definition of AIFs includes venture Capital Fund, hedge funds, private equity funds, commodity funds, Debt Funds, infrastructure funds, etc.,while, it excludes Mutual funds or collective investment Schemes, family trusts, Employee Stock Option / purchase Schemes, employee welfare trusts or gratuity trusts, ‘holding companies’ within the meaning of Section 4 of the Companies Act, 1956, securitization trusts regulated under a specific regulatory framework,and funds managed by securitization company or reconstruction company which is registered with the RBI under Section 3 of the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002.
One AIF can float several schemes. Investors in these funds are large lyinstitutional, high net worth individuals and corporates.
Types of AIFs
AIFs are categorized into the following three categories, based on their impact on the economy and the regulatory regime intended for them:
- Category I AIF are those AIFs with positive spillover effects on the economy, for which certain incentives or concessions might be considered by SEBI or Government of India; Such funds generally invests in start-ups 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. They cannot 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.eg. Venture Capital Funds, SME Funds, Social Venture Funds and Infrastructure Funds. Giving effect to the announcement by Union Finance Minister on angel investor pools in the Union Budget 2013-14, SEBI in June 2013 has approved a framework for registration and regulation of angel pools under a sub- category called 'Angel Funds' under Category I- Venture Capital Funds.
- Category II AIF are those AIFs for which no specific incentives or concessions are given. Theydo not undertake leverage or borrowing other than to meet the permitted day to day operational requirements, as is specified for Category I AIFs. eg. Private Equity or debt fund.
- Category III AIF are funds that are considered to have some potential negative externalities in certain situations and which undertake leverage to a great extent; These funds trade with a view to make short term returns. These funds are allowed to invest in CateogyI and II AIFsalso. They receive no specific incentives or concessions from the government or any other Regulator.eg. Hedge Funds (which employs diverse or complex trading strategies and invests and trades in securities having diverse risks or complex products including listed and unlisted derivatives).
Fund raising and investment restrictions for AIFs
AIFsraise funds through private placement and they cannot accept from an investor an investment of value less than Rs. 1 Cr. The fund or any scheme of the fund cannot have more than 1000 investors and each Scheme should have a corpus of Rs. 20 Crore.The manager or sponsor/ promoterof the AIF should have a continuing interest in the AIF of not less than 2.5% of the initial corpus or Rs.5 crore whichever is lower.
AIFs of Category I and II are not permitted to invest more than 25% of the investible funds in one Investee Company while it is 10% for Category III AIFs.
Units of close ended AIFs are allowed to be listed on a stock exchange (but only after final close of the fund or scheme) subject to a minimum tradable lot of 1Crore rupees.
All AIFs are required to comply with the reporting norms to SEBI on a quarterly basis (for Category I, II AIFs and for those Category III AIFs which do not employ leverage) or on a monthly basis (for Category III AIFs which employ leverage). The reporting formats and the method of reporting is specified in the circular dated July 29, 2013.
Category III AIFs also have to additionally comply with norms pertaining to risk management, compliance, redemption and leverage as specified in the circular. The leverage for a Category III AIF is specified not to exceed 2 times i.e. the gross exposure after offsetting for hedging and portfolio rebalancing transactions should not exceed 2 times the NAV of the fund.
Norms in case of application for change in category of the AIF were specified by SEBI vide circular dated August 7, 2013.
Global Regulation for AIFs
Regulation of private pools of capital assumed significance with the financial crisis of 2008. The G‐30 Report in 2009 recommended that ―”Managers of private pools of capital that employ substantial borrowed funds should be required to register with an appropriate national regulator” .In the IOSCO Consultation Report on Hedge Funds Oversight (June 2009), the IOSCO Task Force suggested that progress towards a consistent and equivalent approach of regulators to hedge fund managers should be a high priority. The Task Force recommended that regulatory oversight for hedge funds should be risk‐based, focused particularly on the systemically important and/or higher risk hedge fund managers. Accordingly, IOSCO included effective oversight of hedge funds in its list of objectives and principles of regulations to be complied by Member Countries.
On 8 June 2011, the European Parliament and Council came out with a definition for AIFs under Article 4(1)(a) ofits Directive 2011/61/EU. As per their definition, in a slight contrast to its definition in India, AIFs can mean collective investment undertakings, including investment compartments thereof, which
- raise capital from a number of investors, with a view to invest it in accordance with a defined investment policy for the benefit of those investors; and
- do not require authorization pursuant to Article 5 of Directive 2009/65/EC that applies to undertakings for collective investment in transferable securities (UCITS), (refers to those which invest in exchange traded / liquid financial assets [eg mutual funds]);
On 19 December 2012,EU issued its additional Directive on Alternative Investment Fund Managers (AIFM) such as Hedge Funds, Private Equity Managers, etc for imposing certain restrictions on the dealings of banks etc with them.
Under the Private Fund Investment Advisers Registration Act of 2010, enacted as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, 2010, the regulatory purview over hedge funds and private equity fund advisers was enhanced by the Securities and Exchange Commission in USA. The term used here for AIF is ‘private fund’ which means an issuer that would be an investment company, as defined in section 3 of the Investment Company Act of 1940 (15 U.S.C. 80a–3), but for section 3(c)(1) or 3(c)(7) of that Act.
History of AIF Regulationin India
SEBI (Venture Capital Funds) Regulations (“VCF Regulations”) were framed in 1996 to encourage funding by entrepreneurs’ early-stage companies in India. However, over the years, the Venture Capital Funds (VCF) route was being used by several other funds including Private Equity (PE) funds, Real Estate funds, etc. This made it difficult to target concessions and incentives specific to VCFs without enabling other funds to avail of such incentives or concessions. Further, the investment restrictions placed on VCFs were not suitable for such funds. Hence, on one hand, there were a set of funds like VCF which required incentives and concessions and were comfortable with consequent restrictions attached and on the other hand, there were another set of funds like PE funds which did not require incentives and concessions but required investment flexibility.
Further, since registration of VCF was not mandatory under VCF Regulations, all players in the alternative funds industry were not registered with SEBI. Hence, there was a regulatory gap which needed to be addressed.
The SEBI Board, in its meeting held on July 28, 2011, while considering the agenda on “Plan of Actions for Compliance To Eight New IOSCO Objectives and Principles of Securities Regulation”, approved the proposal for a clear regulatory framework for private pools of capital which may, inter-alia, provide for a mechanism to monitor and assess systemic risks and risks to financial market stability posed by the activities of such funds.
Taking into consideration the above, SEBI proposed a Regulatory framework for Alternative Investment Funds on August 1, 2011 through the concept paper placed on SEBI website along with the draft AIF Regulationswhich was kept open for public comments till August 30, 2011. Through this 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. was also proposed to be excluded from the purview of the proposed Regulations.
Based on the public comments, the revised Regulations were submitted for the approval of the SEBI Board in its meeting held on 2ndApril 2012. The final Regulations were issued on 21 May 2012.
The AIF Regulations is an attempt to extend the perimeter of regulation to hitherto unregulated funds, so as to ensure systemic stability, increase market efficiency, encourage formation of new capital and provide investor protection.