Sebi proposes a change to valuing AIFs' unlisted securities

The regulator has also proposed that any change in methodology/approach within the valuation guidelines prescribed for AIFs also not be considered 'material change'.

The market regulator has proposed that the valuation of unlisted securities held by Alternative Investment Funds (AIFs) be done as per the guidelines issued by the eligible industry association.

Currently, the AIF's guidelines requires that the fund's securities' valuation be done as per Mutual Funds Regulations, with certain exceptions.

For the regulator's proposed change, the AIF industry association has endorsed the International Private Equity and Venture Capital Valuation Guidelines (IPEV Guidelines).

In the consultation paper released on May 23, the Securities and Exchange Board of India (Sebi) has also suggested that this change in valuation methodology not be considered 'material change' under AIF Regulations. Consequently, any change in valuation methodology must follow the existing regulations, which require the fund to give an exit to investors who want to opt out.

Also read: Sebi comes out with standard methodology for valuation of AIFs; modalities for liquidation schemes

The regulator has also proposed that any change in methodology/approach within the valuation guidelines prescribed for AIFs also not be considered 'material change'. But it added that, both old and new valuation methodologies should be disclosed to the investors to ensure transparency.

On changing the valuation methodology, the industry association submitted to the regulator that there the holdings of AIFs and MFs differ in various aspects.

They submitted the following:
1.The valuation norms under the MF Regulations cannot be applied to private instruments held by AIFs, since the Mutual Fund (MF) valuation process is a rule based framework that follows a series of processes (a waterfall of decisions on expanding comparable issuances and issuers) around pricing for investments in open-ended vehicles.

2.AIFs mostly hold private investments where one needs to delve into and present a fundamental valuation based on cash flows pertinent to the underwriting thesis, which Mutual Fund guidelines do not cover.

3. . In addition, the fundamental difference between investments by a MF and AIF is their holding period strategy. A MF holds its investments primarily as “AFS” or “Available for Sale” while an AIF typically holds its investments as “HTM” or “Hold Till Maturity”.

Given these, the regulator has proposed that securities--other than unlisted securities--be continued to be valuated as per MF Regulations and unlisted securities' be valuated based on IPEV guidelines.

Other changes

The regulator has also proposed that the timeline for AIFs to report valuation of investments to performance benchmarking agencies be extended to seven months from the end of the financial year or October of every year. Currently, the timeline is six months from the end of the fiscal or September of every year.

This is because the industry representatives said that the funds' investee companies have six months till the end of every financial year, or till the end of September every year, to complete their audit. The funds therefore will need at least a month more after the investee companies' are done with their audit, or the October of every year.

The representatives also put forward other constraints they face to meet these timelines such as the investee being under litigation or its operations fully halted because of other constraints, and even the fund not being able to get the necessary information in time because it holds very little of the investee company.

The paper has also made a suggestion on the eligibility criteria of the independent valuer.

Currently, the valuer has to be registered with the Insolvency and Bankruptcy Board of India (IBBI) and need to have a membership either with Institute of Chartered Accountants of India (ICAI) or Institute of Company Secretaries of India (ICSI) or Institute of Cost Accountants of India (ICMAI) or CFA Institute.

Or the entity has to be a holding company or subsidiary of a credit rating agency. Or it has to have any criteria as specified by the market regulator from time to time.

Industry representatives sought clarity on whether the valuer who is set up as an entity has to be registered with IBBI and has to have all its directors/partners/employees as members of ICAI/ICSI/ICMAI or CFA Institute.

In the consultation paper, the regulator suggested that the eligibility be clarified as below:

1. such entity or company shall be a registered valuer entity registered with IBBI; and
2. the deputed/authorized person(s) of such registered valuer entity, who undertake(s) the valuation of investment portfolio of AIFs, shall have a membership of ICAI or ICSI or ICMAI or CFA Institute