Genesis of Category III AIFs

Alternate Investment Funds (AIFs) are privately pooled investment funds, incorporated in India, in the form of a trust, company, LLP or body corporate not covered under any other regulations prescribed by SEBI. These funds are governed by Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012[1].

There are 3 types of AIFs namely; Category I, Category II and Category III. In this article we will focus on Category III AIFs.

Section 3(4) (c) of by Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 defines Category III AIFs in the following manner:-

“Category III Alternative Investment Fund” which employs diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives.”

In other words Category III AIFs are those funds that undertake leverage and complex strategies with an objective of making short term gains. Example of Category III AIFs would be hedge funds.

Market Scenario

Currently, institutional investors are not allowed to access the commodities market, resulting in a lack of growth and liquidity in this market. However, investments in AIFs have seen a sharp rise especially from foreign investors.

With a view to capitalize this phenomenal growth and address the issues faced by the commodities market, SEBI on 21^st June 2017, issued a circular titled, “Participation of Category III Alternative Investment Funds (AIFs) in the commodity derivatives market”^[2], allowing category III alternative investment funds (AIFs) to invest in the commodity derivative markets.

SEBI Circular

The circular was issued on the basis of recommendations given by the Commodity Derivatives Advisory Committee (CDAC).The circular sets our several conditions that need to be fulfilled in order to make such investments, namely:-

1. The funds may invest only upto ten percent of the investable funds in one underlying commodity;
2. Category III AIFs can leverage or borrow subject to consent from investors, in accordance with SEBI regulations;

Currently, these funds are allowed to leverage upto a maximum of two times the NAV of the fund.

• These funds will have to make disclosure in the private placement memorandum, that the fund intends to invest in commodity derivatives;

1. The AIF also need to take consent from existing stakeholders. An exit opportunity has to be given to the dissenting investors;
2. The rules, regulations and instructions, etc. applicable to clients of the commodity market shall also apply to category III AIFs.

Conclusion

This is a step in the right direction and has been welcomed with open arms, as it will increase liquidity and depth in the commodities market.

[1] http://www.sebi.gov.in/sebi_data/attachdocs/1337599839661.pdf

[2] http://www.sebi.gov.in/legal/circulars/jun-2017/participation-of-category-iii-alternative-investment-funds-aifs-in-the-commodity-derivatives-market_35146.html

— by Somesh Lund (finserv@vinodkothari.com)