Hammurabi & Solomon Partners - Amit Verma, Kushagra Verma 
The Viewpoint

Unleashing India’s Investment Potential: A Deep Dive into Alternative Investment Funds (AIFs) in GIFT City

The article delves into regulations on setting up Alternative Investment Funds at an International Financial Services Centre, such as GIFT City and the advantages of investing in such AIFs.

Amit Verma, Kushagra Verma

AIFs – A Global Approach

Alternative Investment Funds are privately pooled investment vehicles governed by the SEBI (AIF) Regulations, 2012. However, with the advent of the International Financial Services Centre (Fund Management) Regulations, 2022, the SEBI (AIF) Regulations of 2012 along with various other circulars and regulations have been rendered ineffective to the extent of their applicability to the International Financial Services Centre (IFSC).

As the name suggests (“alternative” investment funds) this kind of investment vehicle provides a substitute for the more traditional forms of investments widely acclaimed in the market like mutual funds, bonds, direct equity among others. The success of AIFs can be directly correlated to its unaltered and unhindered state irrespective of the fluctuations in the public markets.

These funds are established or incorporated in the IFSC as a company, LLP or trust and function by raising capital from individual and institutional investors, including both Indian and foreign investors, with a primary focus on High Net-worth Individuals (HNIs), Ultra High Net-worth Individuals (UHNIs) and other body corporates.

There are three distinct AIF Categories, which further cater to different set of investment opportunities for the prospective investor in the market. These Categories are provided herein below: -

Ø Category I: This includes venture capital funds, SME funds, social venture funds, infrastructure funds or any other funds to target sectors like start-ups, early-stage ventures, social enterprises, Small and Medium Enterprises (SMEs), infrastructure and other areas recognized by the Government regulators.

Ø Category II: This encompasses investments in private equity funds, debt funds, funds of funds and alike. This Category does not undertake leverage or borrowing other than to meet the day-to-day operational requirements.

Ø Category III: This category includes funds such as hedge funds and PIPE funds, involving a very complex and strategic approach, which is often diverse and may involve leverage of tactics by including investments in listed or unlisted derivatives.

The IFSC established in GIFT City, Gandhinagar, Gujarat operates under the Special Economic Zones Act of 2005 and holds the exclusive status of being the only approved IFSC in India. GIFT City is designated as a Special Economic Zone (SEZ), offering various benefits and incentives. Furthermore, within the territory of IFSC, both “entities” and “units” are provided the classification of “person’s resident outside India.”

Positioned as a prominent global hub for financial and IT services, GIFT City is strategically positioned to effectively compete with other well-established IFSCs like the ones established in Dubai, London, Singapore and alike. Investment prospects like minimal operational costs, conducive business environment, and attractive tax policies, among other benefits are worthy of raising eyebrows of any HNI or UHNI and institutions which intend on investing their funds in a safe and regulated space while also reserving the high ROI yielding potential.

According to the provisions set out in the IFSC (FM) Regulations, 2022 or FM Regulations, any entity intending to undertake fund management activities within the purview of the IFSC shall compulsorily register itself as a Fund Management Entity (FME) in accordance with the requirements laid down by the regulations. There are 3 different categories of FMEs (pooling vehicles), which are (i) Authorized FME; (ii) Registered FME (Non-Retail); and (iii) Registered FME (Retail). Individual registration of these pooling vehicles ensure registration for separate products is not required, thereby, further increasing the effectiveness and efficiency of the system.

Upon an AIF’s registration under the FM Regulations, such AIFs are authorized to launch a fund within 21 days following the submission of the Private Placement Memorandum (PPM) to IFSC, provided that all IFSC observations are addressed. Alternatively, funds comprised solely of accredited investors or those operating as venture capital schemes can utilize a green channel, bypassing the need for prior comments from IFSC, thereby enhancing both the speed and cost efficiency of fund management activities within the IFSC framework.

Guidelines under FM Regulations

As per the provisions of the FM Regulations, the applicants are required to establish its presence in the IFSC by forming a company, LLP, branch, or any other structure permitted by the Board. However, Registered FME (Retail) entities are not allowed to operate as LLPs or branches. It is to be noted that the branch structure is only permitted for FMEs that are already registered or regulated by a financial sector authority established in India or any other authority established in a foreign jurisdiction for conducting similar activities. Similarly, entities operating as branches in the IFSC must ensure their operations within the IFSC are adequately ring-fenced, i.e., its funds are allocated for carrying out the activities related to the branch itself. As per the FM Regulations, the entities are also required to meet the minimum net worth requirements specified by the regulations, maintain specified capital earmarked for IFSC operations, and adhere to any other requirements stipulated by the Board. Additionally, the corporate structure must explicitly authorize fund management activities, and Registered FMEs (Retail) must have at least four directors, with fifty percent being independent directors.

Qualifications and Management of FMEs

The FM Regulations have put forth guidelines detailing the roles, responsibilities and obligations of applicants and the personnel appointed thereto. Under the regulations, any applicant must appoint a principal officer responsible for overall activities, including fund management, risk management, and compliance. Registered FMEs must also designate a Compliance and Risk Manager, and Registered FMEs (Retail) must appoint an additional Key Managerial Personnel (KMP) for fund management. Principal officers and KMPs must be based in the IFSC and meet specific qualifications, including a professional or postgraduate degree in relevant fields and at least 5 years of experience in related securities market activities. Proposals on portfolio composition must originate from personnel based in the IFSC, and the FME must appoint personnel proportional to its operational size. Any changes to KMPs require prior approval from the Authority.

The entities must also comply with the minimum net-worth requirements, which are as follows: -

Authorized FME: Minimum USD 75,000;

Registered FME (Non-Retail): Minimum USD 5,00,000;

Registered FME (Retail): Minimum USD 1,000,000;

Apart from these minimum net-worth conditions, the registered entities must ensure sufficient funds for daily operations and other miscellaneous activities.

Parameters and Guidelines under FM Regulations

The applicant, including its principal officers, directors, partners, KMPs, and stakeholders, must meet the fit and proper criteria, demonstrating financial integrity, good reputation, and honesty. Grounds for disqualifications include convictions for moral turpitude or economic offenses, pending recovery proceedings, insolvency, regulatory bans, and other specified criteria. Entities must also ensure adequate infrastructure, including office space, equipment, communication facilities, and manpower, proportional to their operations in the IFSC. Issuance and validity of the registration certificate shall be subject to the requisite fees, audit, inspection or clarification from authorities, as the case may be. 

Furthermore, the FMEs shall only be able to launch schemes upon appointing the Board of Directors in the case of a company, partners in case of an LLP and trustees in case of a Trust. These appointments are collectively known as “fiduciaries” and are required to comply with the code of conduct prescribed under the FM Regulations. Moreover, any FME intending on launching any retail scheme shall take prior approval from the authority for the appointment of any additional fiduciary.

Advantages for Investors under IFSC through the AIF model

Major advantages of AIFs in the IFSC realm:

Ø Tax Benefits - Investors shall consider the alluring taxation advantages provided by IFSC including a 10-year tax holiday (a 100 per cent tax exemption) and GST exemptions. AIF managers are eligible to receive these perks in relation to their income received against fund management income. Under Section 115UB of the Income Tax Act, 1961, the tax pass-through status for Category I and II AIFs has been extended. Meeting the “specified fund” requirements, which include a reduced tax rate on revenue pertaining to capital gains and interest, is relevant for Category III AIFs;

Ø Open gates for Foreign Investors and Cross Border Investments - Owing to the SEZ status, the core objective of setting this IFSC was to promote and welcome trade and investment opportunities from throughout the globe. The regulatory framework of the AIFs in IFSC is structured in a manner, which promotes smooth registration of entities irrespective of nationality. By providing opportunities for cross-border investments to entities or investors residing in the IFSC, AIFs have enabled such investors to diversify their portfolio and increase chances of significantly higher returns. Furthermore, vide the Circular bearing IFSCA-FMPP0BR/12/2023-Banking dated January 8, 2024 issued by the IFSCA, the authority has advised the IFSC Banking Units (IBUs) using SWIFT as messaging service to consider using MT 910 (confirmation of credit message) instead of MT 940 (customer statement message) for crediting accounts to enhance the processing times of its constituents in cross-border payments. The authority has also directed the IBUs to undertake a study to document their existing method of processing cross-border payments and lay out ways in which such processing speeds can be increased; and

Ø Increase in the GDP of India – India’s GDP is primarily dependent on government spending, investments, imports and exports. The initiative of incorporating AIFs in IFSC has the potential to increase cross-border investments by manifolds. Moreover, the cherry on top is the use of USD instead of INR in all transactions within the IFSC, as the territory granted to the IFSC is considered as a “jurisdiction separate from the rest of India." Further, to promote and improve the ease of doing business, the IFSCA vide Circular bearing F. No. IFSCA-AIF/32/2024-Capital Markets dated April 5, 2024, has decided that for all funds/ schemes to be launched under Chapter III (Retail Schemes) of the FM Regulations, the FME shall submit the PPM along with other documents ensuring minimum disclosures and other requirements. The authority has also mentioned that in due course of time, a web-portal would be established for filing of scheme documents before an offer is made.

Our Viewpoint

In view of the probing investors including HNIs and UHNIs, AIF schemes in the IFSC offer significant benefits including diversification, higher possibility of lucrative returns, minimal linkage with public markets, flexibility, access to expertise, and significant tax benefits such as a 100 per cent exemption and a 10-year tax holiday. Moreover, the unique regulatory framework of IFSC coupled with its SEZ status promotes cross-border investments, which further attracts investors from all around the globe, thereby, aiding India’s growth and development. Therefore, since “one size does not fit all”, an investor’s preference under AIF should depend on individual investment goals and risk tolerance.

About the authors: Amit Verma is a Partner Designate and Kushagra Verma is an Associate at Hammurabi & Solomon Partners.

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