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Amendments to SEBI (Alternate Investment Funds) Regulations, 2012

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On May 05, 2021, the Securities and Exchange Board of India (“SEBI”) brought in a slew of changes to the SEBI (Alternate Investment Funds) Regulations, 2012 (“AIF Regulations”) aimed at improving clarity and accountability with respect to alternate investment funds (“AIFs”) and their functioning via the SEBI (Alternate Investment Funds)(Second Amendment) Regulations, 2021 (“Amendment”).

Broadly, the Amendment brings in changes that (i) seek to clarify or expand certain definitions of the AIF Regulations, (ii) introduce the concept of simultaneous investments by AIFs in other AIFs as well as investee companies, and (iii) introduce a code of conduct for AIFs and relevant stakeholders to improve accountability.

The first key change introduced through the Amendment is providing clarity on the definition of a ‘start-up’. SEBI has now aligned the definition of start-up under the AIF Regulations with that followed by the Department for Promotion of Industry and Internal Trade (“DPIIT”). As per the DPIIT’s definition, an entity would be considered a start-up (i) upto 10 years of its incorporation/ registration; (ii) if turnover of the entity for any of the financial years since incorporation/ registration has not exceeded one hundred crore rupees; and (iii) if the entity is working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation. Further, the definition of a venture capital undertaking (“VCU”) has been simplified and broadened by removing the earlier list of restricted activities from the definition of a VCU under the AIF regulations. The effect of this change is that Category I AIFs, such as VCUs, can now invest in NBFCs unlike before. The Amendment also substitutes ‘venture capital undertakings’ under sub-regulation (1) of regulation 19F of the AIF Regulations with the word ‘start-ups’, implying that angel funds can now invest in start-ups rather than VCUs, thus widening the investment scope of angel funds in general.

The second key change introduced by the Amendment is the introduction of the concept of simultaneous investment in securities of investee companies and units of other AIFs. As per the structure, AIFs can now either directly invest in the securities of the investee companies, or can choose to invest in units of an AIF that invests in the securities of the investee companies. Prior to the Amendment, a Category I AIF Fund of Funds (“FoF”) was restricted to invest in units of only Category I AIFs. Further, Category II and Category III FoFs were also restricted to invest in units of Category I or Category II AIFs. Further, AIF FoFs were not permitted to invest in units of other AIF FoFs. The Amendment has revised the provisions of Regulation 15(1), Regulation 16(1), Regulation 17, and Regulation 18 to accommodate investments in units of other AIFs, while maintaining the ceiling of 25 percent investment in any one investee company in case of Category I and Category II AIFs and a ceiling of 10 percent for Category III AIFs. It has further been clarified that AIFs investing in other AIFs are not permitted to offer their units for investments to other AIFs.

The third key change introduced by SEBI was to revamp the general obligations of the key management personnel of the AIF, trustee, the trustee company, directors of the trustee company, designated partners or directors of the AIF. The Amendment introduced Schedule IV to the AIF Regulations providing codes of conduct for the AIFs, the key management personnel of the AIF, trustee, trustee company and its directors, managers, key management personnel of the managers, and the members of the investment committee to abide by in order to improve transparency and accountability. As per the Amendment, policies and procedures of AIFs need to be jointly approved by the AIF trustee and the AIF manager, who shall be responsible to ensure that the working of the AIF is in tandem with the AIF regulations and other applicable laws. The members of the investment committee are also required to ensure their decisions are in compliance with relevant laws, thereby shedding some clarity on the responsibilities of such members.

The Amendment has introduced much required changes providing an impetus to the AIF industry. By harmonising the definition of start-ups with the definition prescribed by the DPIIT, SEBI has eased the procedure for investments by AIFs into start-ups and has simplified the regulatory compliance requirements that the investor as well as investee entities would be required to follow. Further, by allowing AIFs to invest in the units of AIFs as well as the securities of investee companies, the Amendment has introduced necessary flexibility in the investment structure of AIFs, which has been long requested by global investors. Finally, by revising the general obligations and managerial responsibilities of the AIF, its trustee, and trustee companies, and their key management personnel and designated partners, the Amendment has introduced measures that will further strengthen the corporate governance mechanism of such entities.