The Viewpoint: Alternative Investment Fund - Regulations and Perspectives

Bar & Bench August 10 2018
S Jalan & Co

Samrat Sengupta

Alternative Investment Fund (AIF) is defined in Regulation 2(1) (b) of the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012.

AIFs are the Funds being privately capitalised investment vehicle formed by the collection of funds from investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors.

It may be in the form of a trust or a company or a limited liability partnership or a body corporate. Hence, in India, AIFs are private funds which are otherwise not coming under the jurisdiction of any regulatory agency in India.

Necessity

Worldwide the Non Pragmatic and Risk – Aversion funding policies of the Banking Sector, as well as the NBFC Sector, has given rise to the necessity for the germination of AIF. It mainly caters to the unorganised but hugely potential SME and Start-Up Sector.

Presently the Government of India has been proactive in trying to establish a regulatory and tax climate that is conducive for raising investment from foreign investors. In 2016, the government made efforts to encourage domestic financial institutions such as pension funds and insurance firms to allocate investments towards the AIFs.

The regulatory regime continues to be streamlined with the relaxation of pricing norms for foreign direct investments, clarity in relation to put/call options, rationalization of the foreign portfolio investment regime and proposals for further liberalization of investment caps in the AIFs.

Guiding Regulation

The AIFs in India are regulated by the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 w.e.f 21.05.2012. This Regulation provides for the eligibility to be categorised as AIF, registration of the AIFs with the SEBI, investment and its conditions and restrictions, monitoring and penal powers of SEBI etc.

AIF Regulations endeavour to extend the perimeter of regulation to unregulated funds with a view to ensuring systemic stability, increasing market efficiency, encouraging the formation of new capital and consumer protection. Apart from the registration and compliance requirements under the AIF Regulations, each AIF also needs to be compliant with the applicable statutes, depending upon the chosen structure of trust, LLP or a company.

Classifications of AIF

An AIF can seek registration broadly under one of the 3 categories –

Category I AIF:

  • Funds investing in start-up or early-stage ventures or social ventures or SMEs or infrastructure
  • Other sectors or areas which the government or regulators consider as socially or economically desirable including the Venture Capital Funds
  • AIFs with positive spillover effects on the economy, for which certain incentives or concessions might be considered by SEBI or Government of India or other regulators in India

This category mainly deals with the AIFs which invests in start-up or early-stage ventures or social ventures or SMEs or infrastructure. Includes venture capital funds, SME funds, social venture funds, infrastructure funds, angel funds, etc.

The Angel funds, which is of particular interest these days, means funds pooling investments from angel investors, having a net worth of at least Rs. 10 Crores (if a body corporate); or net tangible assets of at least Rs. 2 Crores, excluding the value of the principal residence, and experience as a serial entrepreneur, or being a senior management professional with at least 10 years of experience (if individual).

Also, the income on an investment fund under the Category I AIF is exempted from tax and such income is chargeable to income-tax in the hands of the unit-holder in the same manner as if the investments made by the investment fund has been made directly by the unit-holder.

Category II AIF:

AIFs for which no specific incentives or concessions are given by the government or any other Regulator

  • Which shall not undertake leverage other than to meet day-to-day operational requirements as permitted in these Regulations
  • Which shall include Private Equity Funds, Debt Funds, Fund of Funds and such other funds that are not classified as category I or III

AIFs, which do not fall in Category I or Category III and which do not undertake leverage or borrowing other than to meet day-to-day operational requirements. Includes private equity funds or debt funds for which no specific incentives or concessions are given by the government or any other regulator. Also, the income on an investment fund under the Category I AIF is exempted from tax and such income is chargeable to income-tax in the hands of the unit-holder in the same manner as if the investments made by the investment fund has been made directly by the unit-holder.

Category III AIF:

The AIFs including hedge funds which trade with a view to making short-term returns;

  • Which employ diverse or complex trading strategies
  • Which may employ leverage including through investment in listed or unlisted derivatives

This category covers the AIFs, which employ diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives. This Includes hedge funds or funds, which trade for short-term returns, or open-ended funds, for which no specific incentives or concessions are given by the government or any other regulator.

Exclusivities

Currently, the AIF Regulations do not apply to mutual funds, collective investment schemes, family trusts, ESOP and other employee welfare trusts, holding companies, special purpose vehicles, funds managed by securitisation or reconstruction companies and any such pool of funds which is directly regulated by any other regulator in India.

Foreign Investment Participation

The government of India in the Budget for the year 2016-2017 has allowed the Foreign Investment in the AIFs. Now Foreign Investments would be allowed in AIFs that are established as a registered trust, structured as an incorporated company or an LLP. This decision would be enabled in the FDI Policy and the FEMA Regulations.

Now that the foreign investors are allowed to participate in AIFs, it is expected that these funds will attract investments from NRIs and overseas institutions. The merger of FDI and FPI will minimize the administrative bottlenecks of investing and increase the flow of long-term capital. The procedural ease will also give confidence to global investors.

Also, along with category-I, category-II funds have been given a tax benefit and the end-investor shall bear the tax liability, while the private equity and real estate funds will have more money.

Conclusion

With eased norms of participation of domestic as well as the foreign capital, the AIF industry in India is expected to leap forward at an accelerated growth. With long-term money coming into unlisted securities, which was not the case till now, these funds may see accelerated growth. The Indian Economy will get a boost of investments in the country through the AIF.

Samrat Sengupta is a partner at Jalan & Company.