Sebi may tighten AIF regulations to better monitor the source of funding

The Securities and Exchange Board of India (Sebi) plans to tighten present Alternative Investment Funds (AIF) regulations to better monitor the source of funding and their end use.

According to sources, Sebi may check the anti-money laundering policies implemented by AIFs and examine the sanctity of any back-end arrangements an AIF may have with its investors, whereby money raised in AIFs is invested back in entities owned by the investors.

The regulator may also conduct regulatory audits on the AIFs to examine the fund sourcing arrangements it has entered into with its investors to ensure that the present regulations are not violated.

AIFs can raise money from both domestic and overseas investors. Unlike mutual funds which can raise overseas money only from foreign portfolio investors (FPIs) and NRIs, AIFs can do so from all classes of overseas investors.

Keeping in view the wide range of investors from whom the money can be raised and the limited number of the investor base, Sebi may be inclined to monitor the source of funding to ensure that the AIF route is not misused, said Tejesh Chitlangi, partner, IC Universal Legal. The recent Sebi order against one of the AIF, wherein the money was raised from the investors to fund their own projects may also have prompted the move.

There are certain grey areas in the AIF regulations, which the regulator may be keen on addressing, said experts. For instance, present regulations contemplate the investment in debt which has prompted certain funds to give loans which otherwise cannot be done under the present Sebi and RBI norms.

A recent adjudication order passed by a Sebi officer observed that SREI AIF had floated a fund and gave out loans instead of investing in debt securities. The AIF regulations do not permit granting of loans as this would tantamount to operating an NBFC through the AIF route.

Sebi had allowed the information memorandum to go through without adequate scrutiny. After the adjudication order became public, Sebi is understood to be issuing a clarification circular, said PR Ramesh, advocate, Bombay High Court.

The larger issue pointed out Ramesh, is how the AIF route could be used to circumvent other laws. Related-party transactions, for instance, can be concealed using AIF as pass-through.

It may be necessary for making some disclosures public, particularly when paired companies are involved as investor or investee, said Ramesh.

The provision which prohibits venture capital funds from investing in NBFCs still continues and this has created practical hardships in today's era of fintech VCs, said experts. Similarly, there is ambiguity with regard to calculating the unlisted versus listed investment portfolio for Category II AIFs which needs more clarity.

Some ambiguities may simply be addressed by issuing a clarificatory circular. Others may need an amendment in the regulations, said Chitlangi. Investment commitments of AIFs reached Rs 1.41 trillion as of December 2017, a more than fourfold jump from Rs 30,687 crore two years ago, Sebi data shows.

The surge in assets is a function of the easing regulatory framework, options for customisation and robust returns. Besides providing for a pass-through to category I and II AIFs the government has affected several other changes in the past three years.

For instance, the holding period for availing of long-term capital gains in the investments made by AIFs in the unlisted space was reduced to two years from three years. The one-year lock-in period for AIFs post-initial public offerings has been done away with.

AIFs are privately-pooled investment funds, categorised into three categories. Category I funds invest in start-ups, small and medium-sized enterprises (SMEs) and venture capital. Category II funds include private equity funds and debt funds, while category III includes hedge funds.