Variable capital companies (VCCs), which are pooled private equity fund structures that can facilitate flexible capital management, have been introduced in this year's Union Budget by the Finance Minister, Ms. Nirmala Sitharaman. The concept of a VCC in India has been under discussion for some time, with the International Financial Services Centers Authority (IFSCA) proposing a legislative framework to permit such entities. In October 2022, the Sahoo Committee issued a report outlining a specific legal framework for VCCs within the IFSCs and recommended amending the IFSCA Act, 2019 for this purpose, even while advising against amending the Companies Act, 2013 to recognize VCCs for domestic funds, suggesting instead that VCCs should be initially limited to foreign funds in the IFSCs. This incremental regulatory approach was meant to allow for testing VCC structures in the IFSC before potentially expanding it domestically, a phase-in typical of many corporate reforms in India.
The latest announcement by the Finance Minister promises to establish VCCs as a vital tool for fund structuring and management in India. This note analyzes the key attributes of VCCs in the Indian context and the reasons for their popularity amongst funds across global financial centers.
What is a VCC: At its core, a VCC is a corporate entity, that offers limited liability and is designed to allow easy issuance of fresh shares without requiring regulatory filings and shareholder approvals, offering a progressive approach in the investment fund sector, delivering considerable flexibility and efficiency in terms of distributions, redemptions and repatriation of profits. This flexibility allows the VCCs to be used in creative ways across different fund strategies, investor and asset classes and operates on a master-feeder structure.
Setting up a VCC in India: A VCC can be set up as a company or an LLP and can function either as an umbrella entity issuing sub-funds or as a standalone VCC making direct investments. Within a VCC, one sub-fund may be allowed to invest in another sub-fund of the same VCC. Both VCCs and their sub-funds can issue equity and debt securities, and the sub-funds can be open-ended or closed-ended.
Regulatory considerations: Classified as alternative investment funds (AIFs) in India, a VCC must still obtain an AIF license from SEBI. From a tax perspective, each sub-fund should ideally be regarded to be a separate person, with the tax law therefore being applied separately for each such sub-fund. Tax residency certificates should also be issued to each sub-fund to enable them to take advantage of India's tax treaties. The overlap of existing applicable legislation (the Companies Act, 2013, the LLP Act, 2008 and the Indian Trusts Act, 1882) with the proposed VCC framework will also have to be carefully considered.
Advantages of a VCC structure: The umbrella holding structure of VCCs provides each sub-fund with distinct regulatory status, simplifying compliance and risk management, by way of segregation and ring-fencing of diverse asset pools and liabilities. This structure allows fund managers to create sub-funds with varying risk profiles and investment strategies, accommodating varying preferences. Similarly, adding sub-funds under an umbrella VCC allows fund managers to help sponsors/asset owners securitize and unlock asset value in a plug-and-play model. VCCs will also eliminate the need for trustees by having the VCC board take on these responsibilities, which could be perceived as further reducing costs. Investors also stand to benefit from the consolidation of multiple funds under the VCC – consequently limiting operational costs, with the savings passed on to investors by way of lower management fees charged by fund managers. the VCC framework supports flexible payout structures, enabling customized dividends and capital gains based on individual sub-fund performance.
Challenges: Some regulatory and compliance issues will require more clarity. As an illustration, under the current SEBI (AIF) Regulations, 2012, notwithstanding how many schemes an AIF has, the sponsor and fund manager must be the same across schemes. If a new fund manager and sponsor is sought to be brought in, the AIF will require to establish a new fund and obtain a fresh license. However, a VCC structure should allow for different managers and sponsors across its sub-funds without triggering a separate registration requirement. VCCs should also be adopted in such a way that allows for mergers of schemes with others, between sub-funds without necessarily going through an NCLT-led process. Clarification on these and other pertinent aspects will be vital to the success of VCCs in India.
Our view
The structure of VCCs represents a shift away from path-dependent tendencies of the traditional private trust structures prevalent in India. Countries like Singapore, Mauritius, and the UAE already have VCC frameworks in place and have utilized this to establish themselves as appealing destinations for capital pooling and international investment. Singapore excels with its investor-friendly regulatory framework – the Variable Capital Companies Act, 2020 – liberalized government policies, and streamlined establishment process facilitated by the Monetary Authority of Singapore, resulting in around 1,000 VCCs with over 2,000 sub-funds since 2020. The UAE, particularly through the Dubai International Financial Centre (DIFC) and Abu Dhabi Global Market, attracts VCCs with its progressive regulatory environment and zero-tax regime on most investment income.
While transparency for investors, regulators, and investees will be crucial to the success of VCCs, the growth of the VCC industry will also be a function of the clarity and certainty of rules issued by the Government, since investors may be wary of a new structure whose tax and regulatory treatment is untested. A progressive, investor-centric regulatory and tax framework will have to be developed – for example, VCCs should be allowed to issue/buyback the securities issued by them or reduce their capital without restrictions. Given that VCC structures do not discriminate between asset classes, one can expect greater traction in venture capital, private equity, family offices, private real estate investments, infrastructure, fund of funds, private credit and debt funds, and hedge funds. We may also see a segment of the offshore financial services business being brought back to India, and an increase in the global competitiveness of Indian IFSCs. Coupled with the GIFT City ecosystem, a strong regulatory framework that supports VCCs can greatly boost domestic capital flows into alternative investments by allowing Indian investment houses to align their investments with their strategies and offer more liquidity options.
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