The Securities and Exchange Board of India ("SEBI") has enacted significant amendments to the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012, through the Securities and Exchange Board of India (Alternative Investment Funds) (Fourth Amendment) Regulations, 2024 ("Amendment Regulations"). These Amendment Regulations are a response to the evolving landscape of alternative investment funds ("AIFs") and aims to streamline regulatory frameworks while enhancing operational flexibility for fund managers.
KEY CHANGES IN THE REGULATIONS
- Omission of Operational Requirements: One of the notable changes is the removal of the phrase "to meet day-to-day operational requirements" from Regulation 3, sub-regulation (4), clause (b). This amendment simplifies the language and potentially reduces any regulatory compliance burden on fund managers, allowing them to focus more on investment activities rather than administrative requirements.
- Extension of Fund Tenure: The regulations now permit large value funds for accredited investors to extend their tenure up to five years. This extension is contingent upon the approval of at least two-thirds of the unit holders based on the value of their investments. This provision is particularly significant as it provides greater flexibility for fund managers to manage long-term investments, accommodating the needs of investors who may prefer extended investment horizons.
- Borrowing Restrictions: The amendments introduce specific borrowing guidelines for Category I and Category II Alternative Investment Funds. Both categories are prohibited from borrowing funds or engaging in leverage for investment purposes, with exceptions made for temporary funding needs. Funds may borrow for a maximum of thirty days on no more than four occasions each year, limited to ten percent of their investable funds. This restriction aims to mitigate risks associated with excessive leverage while still allowing funds to manage short-term liquidity needs effectively.
- Encumbrance on Equity: The regulations allow Category I and II AIFs to create encumbrances on the equity of investee companies involved in infrastructure projects. This encumbrance can only be for the purpose of borrowing by the investee company and must comply with conditions specified by SEBI. This provision is particularly relevant for funds investing in infrastructure, as it provides a mechanism to secure financing while ensuring that the investee companies can leverage their equity for operational needs.
These Amendment Regulations to the AIF regulations marks a strategic shift in SEBI's approach to regulating alternative investment funds, emphasizing enhanced operational flexibility while maintaining a strong regulatory framework1. On August 19, 2024, SEBI issued a circular detailing new guidelines for borrowing by Category I and Category II AIFs, as well as permissible limits for extending the tenure of Large Value Funds ("LVFs"), effective immediately.2
GUIDELINES FOR BORROWING BY AIFS
SEBI has issued guidelines allowing Category I and II AIFs to borrow funds in limited circumstances to cover shortfalls in investor drawdowns, while maintaining strict restrictions on leverage for investment purposes. AIFs must disclose any intention to borrow in their private placement memorandum, and borrowing is only permitted in emergencies when an imminent investment opportunity exists and the drawdown has not been received despite the manager's efforts. The amount borrowed cannot exceed 20% of the proposed investment or 10% of the AIF's investable funds, costs are allocated to defaulting investors, and a 30-day cooling-off period is required between borrowings. These measures balance operational flexibility with investor protection by ensuring borrowing is used judiciously and transparently, while maintaining the overall restriction of 10% of investable funds on up to four occasions per year for a maximum of 30 days.
EXTENSION OF TENURE FOR LVFs
The circular also addresses the tenure of LVFs, allowing them to extend their investment period by up to five years, contingent on the approval of two-thirds of unit holders by investment value. Earlier, permission could have been given for an extension of tenure beyond two years, subject to the terms of the contribution agreement, other fund documents, and conditions by the Board. This extension is crucial for LVFs that may require additional time to realize their investment strategies effectively. Existing LVF schemes that have not defined a specific extension period in their private placement memorandum or have periods extending beyond the new five-year limit must realign their extension periods within three months of the circular's issuance, by November 18, 2024. They are required to update this information in their quarterly reports submitted to SEBI. While revising their tenure, LVF schemes must obtain consent from all investors and submit an undertaking to SEBI confirming this consent. This ensures that investors are actively involved in decisions affecting their investments.
CONCLUSION
Recent amendments to the SEBI (Alternative Investment Funds) Regulations, 2012, reflect SEBI's commitment to balancing operational flexibility for AIFs with regulatory oversight. By permitting Category I and II AIFs to encumber their equity holdings and extending the tenure of LVFs, SEBI acknowledges the industry's evolving needs while prioritizing investor protection. These proactive measures instil confidence in the sustainable growth and integrity of AIFs investments in India, with stakeholders looking forward to further developments that will shape the industry's future.
Footnotes
1 https://www.sebi.gov.in/legal/regulations/aug-2024/securities-and-exchange-board-of-india-alternative-investment-funds-fourth-amendment-regulations-2024_85550.html
2 https://www.sebi.gov.in/legal/circulars/aug-2024/guidelines-for-borrowing-by-category-i-and-category-ii-aifs-and-maximum-permissible-limit-for-extension-of-tenure-by-lvfs_85909.html
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.