SEBI greenlights comprehensive overhaul of operational dynamics of AIFs

SEBI board meeting was held on March 29, 2023

The Securities and Exchange Board of India (SEBI), in its board meeting on March 29, ushered in a major overhaul for the internal and external dynamics of Alternative Investment Funds (AIFs), which will have far-reaching impact on the operations of these funds and their present equation with investors.

To improve governance and transparency for investors with respect to transactions involving conflict of interest, the board has approved a proposal to mandate obtaining approval of 75 percent of investors by value, for buying or selling of investments potentially involving conflict of interest.

"If a single investor holds more than 50 percent of the corpus, that person is considered a related party...if you deal with him or associated with him, then it will need separate approvals," SEBI Chairperson Madhabi Puri Buch said, while addressing the press after the board meeting.

The provision would cover transactions by an AlF, from or to, associates of AIF, or schemes of AIFs managed or sponsored by the manager or sponsor or their associates, or an investor who has commitment to the extent of more than 50 percent of the corpus of the scheme of AlF, the regulatory body chief explained.

Earlier in January and February of this year, the market regulator released a number of consultation papers seeking inputs from the public at large on several operational dimensions of AIFs.

Consultation papers on wide-ranging issues- spanning the establishment of a standardised approach to valuation of investment portfolios of AIFs, dematerialisation of the units of AIFs, investor consent on buying and selling from/to associates of AIFs as well as providing options to AIF investors to carry forward unliquidated investments of a scheme- were released.

With respect to the valuation of the investment portfolio, it is proposed that managers of all SEBI-registered AIFs shall be required to ensure that an independent valuer computes and carries out the valuation of investments made by the scheme(s) of AIFs in accordance with the stipulated guidelines.

Secondly, the Manager shall be required to be responsible for true and fair valuation of the investments made by the scheme of the AIF, provided that where the established policies and procedures of valuation do not result in fair and appropriate valuation, the manager may be required to deviate from the established policies and procedures in order to value the assets or securities at a fair value and document the rationale for such deviations

Thirdly, any such deviation from the disclosed valuation policy and procedures shall be allowed along with disclosure of the documented rationale to the trustee or the trustee company or the Board of Directors or designated partners of the AIF and investors of the AIF.

In the case of each asset, in case, there is a deviation of more than 20 percent between two consecutive valuations of more than 33 percent deviation in one financial year, the manager shall be required to inform the investors the reasons and factors underpinning the same, both generic and specific, including but not limited to change in accounting practices or policy or changes in assumptions and projections or changes in valuation methodology.

As far as providing options to investors for exiting at a time when the scheme tenure is coming to an end and the investments are yet to be liquidated, the regulator has mandated that after an extension of two-years, the manager of the AIF may close the existing scheme and transfer the unliquidated investments to a new scheme, subject to obtaining the consent of 75 percent of investors by value.

The prescribed transfer can be carried out provided that the AIF manager arranges bids for a minimum of 25 percent of the unliquidated investments to provide exits to the investors who do not wish to continue in the new scheme. The AIF/manager shall offer pro-rata exit to all participating investors who choose to redeem their units through this option.

The value of the aforementioned exits must be provided to other investors along with the valuation carried out by two independent valuation agencies.

In case the 25 percent bids are secured from related parties of AIFs or other existing investors, this information should be disclosed to all investors.

In case, the manager fails in securing fresh bids for 25 percent of the unliquidated investments, the closing valuation of the scheme will be based on the liquidation value as determined under IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, or other applicable IBC norms.

The performance of the fund managers shall be computed in accordance with the value at which investors are provided exit or liquidation value, as the case may be.

Lastly, in case, the approval of 75 percent of the investors by value is not received either for internal disbursement or transfer to a new scheme, then, the manager shall mandatorily liquidate the investments at liquidation value within a year of expiry.

Currently, units of AIFs are delivered in a physical form inconveniencing the investors. As on December 31, 2022,  there are 1022 AIFs registered with SEBI. As per the information collected from depositories, it is observed that only 12 ISINs have been created with CDSL for 5 schemes of AIFs as on October 03, 2022, and 87 ISINs have been created with NSDL for 29 schemes of AIFsas on December 20, 2022.

SEBI has mandated that the dematerialisation of units of AIFs shall be made mandatory. As part of the first phase of this mandate, by April 01, 2024, all schemes of AIFs with a corpus more than INR 500 crores shall compulsorily dematerialise their units. Further, the terms of transfer of units of AIFs held by an investor shall continue to be governed by the terms of private placement memorandum (PPM), agreements made with the investor and other fund documents .