Sebi seeks details of ‘side letters’ from AIFs: Sources

Side letters are additional agreements between a specific investor and the AIF over and above the general terms and conditions applicable for the general investors

Several Alternative Investment Funds (AIFs) have received data requests from Indian market regulator the Securities and Exchange Board of India(Sebi) seeking details of so-called side letters the funds have signed with their investors, said two people with direct knowledge of the matter.

These requests from Sebi are part of a data collection exercise being conducted by the market regulator to understand what sort of special rights are being offered by AIFs to some investors. Based on the data collected, Sebi would consider if any further tweaks to the rules are required, the people cited above added.

Side letters are additional agreements between a specific investor and the AIF over and above the general terms and conditions applicable for the general investors. Generally, the funds enter into such agreements with large strategic investors who get certain special privileges compared to the other investors.

Unlike mutual funds where such side agreements are prohibited, Sebi rules allow AIFs to enter such agreements provided they don’t adversely impact the general rights of other investors.

An email sent to Sebi seeking comments remained unanswered.

One of the persons cited said some of the issues Sebi intends to track through the data collection include clauses on co-investments terms, stop funding rights, excuse rights and most favoured nation(MFN) clauses. “This is a unique situation in terms of data collection since Sebi is asking AIFs to disclose private agreements entered between the fund and investor. We understand the data collection is to ascertain if there is any need for new rules to protect the investor interest.”

A MFN clause allows one investor of an AIF to get all rights given to other LPs in their side letters provided the other investors are making smaller or equal contribution. This implies an investor with a MFN clause can get sweeter deal terms than originally agreed upon, provided such terms have been offered to others. Investors who don’t have MFN clause may end up subscribing to the fund as per the original terms even if some other investor subsequently gets better terms.

Co-investment is a model where select investors take additional exposure to a portfolio company where the AIF has already invested. Stop funding rights mean certain investors be able to stop contributing to the fund if there are events of default by the manager. Excuse rights means, an investor can get excused from participating in an investment being made by the AIF under certain special conditions.

Another key area Sebi has been looking into is around the rights of certain investors in LP Advisory Committees. These are external committees that AIFs constitute comprising of key investors in funds. The committee provides guidance from time to time on various aspects of the fund including investments.

The side letters stipulate the powers a specific investor has in such committees. While the rules permit such committees, there have been cases where it was observed some advisory committee members were exercising disproportionate influence on the AIF.

“Legally, the LP advisory committee shouldn’t have any powers and the investment team of the fund manager must act independently in the interests of all investor. Infact, the liability if anything goes also wrong falls under the fund manager, not advisory committee. Hence, Sebi is not comfortable with advisory committee exerting too much influence,” said one of the people cited.

The side letters also contain other crucial information including format of drawdown notices, rights of investors to field visit portfolio companies and any special confidentiality clauses and ‘name usage restrictions’, people cited above added.