Vijay Sambamurthi
April 5, 2012
SEBI AIF Regulations – New & Improved Version?
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It is too early to conclude as to whether the SEBI has “changed its mind” on some of the worrying proposals.

The SEBI issued a press release last Friday announcing that it has decided to approve the issuance of the SEBI Alternative Investment Fund Regulations (“AIF Regulations”). The SEBI had put out a draft of the AIF Regulations last year, inviting public comments. I had written a blog back then, summarizing some of the concerns stemming from the draft AIF Regulations upon a quick read.

The SEBI has not yet issued the text of the final AIF Regulations, and one would of course, have to study the actual text of the AIF Regulations as and when they are issued in order to offer a more detailed and meaningful commentary on the proposed changes from a legal perspective. However, the contents of the press release issued by SEBI make the intent and decision of SEBI on certain key aspects very clear. If one were to go by the language of the press release, and (perhaps, naively!) assume that the text of the final AIF Regulations will not contain any material surprises, the decisions taken by the SEBI broadly seem to be positive. Here’s a summary of some of the key issues/points as proposed by the SEBI, based on the press release. I would again reiterate that it is too early to conclude as to whether the SEBI has “changed its mind” on some of the worrying proposals contained in the draft AIF regulations issued last year.

● Repeal of existing VCF Regulations – The existing SEBI (Venture Capital Funds) regulations, 1996 will stand repealed from the date of notification of the AIF Regulations. However, existing VCFs registered under the VCF Regulations will continue to be governed by VCF Regulations till the life of the fund/scheme comes to an end. Fresh fundraisings by existing VCFs will not be permitted unless they first register under the AIF Regulations. However, to the extent that any commitments have already been formally tied up by existing VCFs on or prior to the date of notification of the AIF Regulations, such commitments will be governed by the existing VCF Regulations.

● Rationalization of AIF Categories – The draft AIF Regulations put out by the SEBI last year sought to classify AIFs into as many as 9 different categories, each requiring a separate registration. This would have been a very burdensome, compliance-heavy and strategy-limiting move which would have greatly impeded the operational efficiency of AIFs. In what appears to be a welcome move, the SEBI press release states that the SEBI has now decided to rationalize the classification of AIFs by limiting it to just 3 categories. This may still impede the ability of a “private equity fund”, for example, to invest in an “early stage venture deal” without registering a separate affiliate entity as a “venture capital fund”. But the reduction in the number of categories is still certainly a very welcome move. One would have to wait for the actual text of the AIF regulations to evaluate how clearly the definitional aspects differentiating these categories of funds are laid out, and one cannot rule out that some level of ambiguity may still find its way into the detail!

● Cap on Corpus Size for VC Funds Removed – The earlier draft AIF regulations had proposed a rather puzzling requirement that AIFs registered as “venture capital funds” could not have a corpus higher than Rs.250 crores (USD 50 million). This curious restriction now appears to have been done away with. There is only mention of a limit of no more than 1000 investors in the SEBI press release. If one assumes that the corpus size limit will not quietly find its way back into the final text of the AIF regulations, this is again, a very welcome move.

● Tax “Pass Through” for AIFs – The SEBI press release states that SEBI will work with the central government to obtain “pass through” treatment for AIFs for tax purposes. This is an interesting proposal because under the existing income tax laws, only “VCFs registered with SEBI” are eligible for this tax treatment. Therefore, if the central government agrees to provide tax “pass through” treatment for all AIFs, that will be a very encouraging move that could facilitate fund investments in general. However, having said that, till the Income Tax Act is formally amended to provide for such “pass through” treatment, there will be a lot of ambiguity around the tax treatment of AIFs registered under the AIF Regulations. If there is significant delay in passing the necessary amendments to the Income Tax Act to effect “pass through” status for AIFs (and this kind of thing has happened before – with LLPs, for example, when it took more than a year to get clarity on the tax status of LLPs), that could adversely affect investment strategies and structuring of AIFs in the interim.

● Listing of AIFs – This is an interesting move proposed by SEBI, wherein AIFs will be permitted to list on recognized stock exchanges in India. However, the minimum tradable lot for AIFs will be Rs. 1 crore (USD 200,000). Raising of fresh funds through the stock market is not permitted. While this may not exactly result in a flurry of capital market activity involving AIFs anytime soon, it is still a significant first step to bringing the Indian market more in line with international norms and practices which in recent times have seen a marked increase in cases of alternative investment firms preferring to list themselves on stock exchanges. Many of us may be aware of a couple of instances in India where PE firms tried to list but which were hindered by unclear regulations in this regard.

As can be seen from above, at least based on the SEBI press release, it appears that the SEBI has been to a lot of pains to take into account industry feedback on the earlier draft AIF Regulations and tried to address many of the concerns. The proof of this pudding, however, will be in reading the actual text of the final AIF Regulations, as and when they are issued.

One crucial implication that strikes me though, is that with the press release having been issued, but the AIF Regulations themselves not being notified, there could be some sort of a temporary “suspense period” as far as fundraising process goes. Many funds that are in the process of being raised will surely now choose to wait and watch till the actual text of the AIF Regulations is issued, before proceeding with the process to closings. Given this factor, it would be good if the SEBI reduces this “suspense period” and proceeds to issue the final text of the AIF Regulations at the earliest, so as to remove the atmosphere of ambiguity that is usually associated with transitionary periods without an expiry date!

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