SynopsisThe Securities & Exchange Board of India (Sebi) has asked several PE and VC applicants to “confirm whether any provision in the private placement memorandum (PPM) is with respect to activity/operations of innovative nature, i.e. not commonly practiced by the AIF industry.”
Mumbai: Private equity (PE) and venture capital funds opening shop in India are being told by the capital market regulator to stay away from ‘innovative structures’, lending, and tampering with existing arrangements to accommodate select big-ticket investors.
Among other things, the regulatory concern may stem from the nature of pooled vehicles like PE and VC funds — known as alternative investment funds (AIFs) in regulatory parlance — which some of the offshore investors have used in an attempt to sidestep restrictions on foreign holding in local companies.
Unlike mutual funds, AIFs tap sophisticated and deep-pocketed local and foreign investors. Even if majority of investors are foreign, a fund’s equity stake in a local company is treated as domestic holding as long as the AIF’s asset management company is locally owned and controlled.
The Securities & Exchange Board of India (Sebi) has asked several PE and VC applicants to “confirm whether any provision in the private placement memorandum (PPM) is with respect to activity/operations of innovative nature, i.e. not commonly practiced by the AIF industry.” The regulator’s attention may have also been drawn to loans given by an AIF to a Kolkata-base finance company whose promoters were in turn the sponsor of the fund.
“There are several queries now raised by Sebi which the regulator didn’t ask AIF applicants in the past. Some of these around lending have put a question mark over the otherwise permitted debenture investments and any innovative structuring of returns/coupons. The regulator fears this to be in the nature of lending, which technically every debenture investment is and has always been permitted by Sebi due to it being an investment in a security/instrument,” said Tejesh Chitlangi, senior partner, IC Universal Legal.
AIFs now have to specifically state whether any clause or section in PPM affects the blind pooling requirement (or pro rata investment rights of investors). Such deviations (which Sebi does not favour) from blind pooling arises when one or a few large investors, interested to take a higher exposure in a target company, uses the AIF vehicle to make the extra investment that the fund or other investors in the fund are not willing to make. For a foreign investor it could be a way to avoid the complications and restrictions of direct investment. “The queries on blind pooling, requiring applicants to highlight any product features which may not be prevalent in the market etc. seem to be the part of an exercise to check any regulatory arbitrage or to upfront prevent any potential in-spirit non-compliance of the regulations,” said Chitlangi.
Sebi’s reservations about lending by AIF may owe its origin to the existing regulatory framework under which loans are given by institutions like banks and non-banking finance companies that are closely regulated by the Reserve Bank of India and have to follow norms on capital adequacy and exposure.
“Sebi’s concern seems to be that given the flexibility offered under the AIF framework, the regime should not be used to launch products that are not in line with Sebi’s objectives. Sebi’s asks are largely to ensure product standardisation so that it becomes easier for the investors to understand the product and avoid the perception of mis-selling. Internationally, fund managers are regulated (rather than the fund itself). Accordingly, despite the larger investor ticket size (of 1 crore) under the AIF regime, Sebi focuses on product definition and attributes in addition to scrutinising the manager and its track record,” said Richie Sancheti, Partner, Algo Legal.
There are close to 700 AIFs in India with investment commitments of about ₹4.5 lakh crore — up from less than 170 funds with commitments of ₹0.3 lakh crore in end 2015. In 2020, Sebi brought in new rules to standardise offer documents and mandatory reporting of performance by AIFs, besides widening responsibilities of a fund’s investment committee members.
Share the joy of reading! Gift this story to your friends & peers with a personalized message. Gift Now