Can India replicate this model?
By Simran Jalan (firstname.lastname@example.org)
On March 23, 2017, Monetary Authority of Singapore (MAS) issued a consultation paper for Singapore Variable Capital Companies. On September 10, 2018, the MAS tabled the Variable Capital Companies Bill (the “Bill”) in Singapore Parliament.
The Variable Capital Company (“VCC”) is a corporate structure that is tailored for collective investment schemes (“CIS”). In Singapore, the most commonly used investment fund structures are unit trusts (constituted by way of trust deeds) and investment companies. The legislative framework for VCC seeks to provide an alternative to incorporating a company under the Singapore Companies Act (“CA”) for the formation of CIS in Singapore.
With the introduction of the VCC structure, the fund managers will have greater operational flexibility. This VCC structure will act as a platform for the fund managers to establish a domicile of their investment funds in Singapore.
This Bill will be administered by the Accounting and Corporate Regulatory Authority (“ACRA”) and will act as the registrar. However, the anti-money laundering and counter-financing of terrorism obligations of VCC will be overseen by the MAS.
Overview of VCC
The VCC structure can be used as a vehicle for CIS and will complement the existing CIS structures available in Singapore. It can be used for both open-ended and closed-ended funds. The VCC is a corporate entity which is allowed to function as a CIS only, and cannot operate any other business.
VCC is a body corporate and shall have shareholders. The shareholders of such a body corporate can be compared to the unit holders in CIS and each share in the body corporate, therefore, corresponds to a unit of CIS.
Further, the Bill requires that a VCC will be managed by a fund manager that is regulated by MAS to manage its investments. The role of the fund manager will be to carry out day to day management and investment activities of the fund. This will help the VCC to mitigate the risk of being “abused for unlawful purposes”. The fund manager will also ensure that the VCC so formed will not be solely used as an offshore vehicle. There must be an investment management activity conducted in Singapore by the VCC.
Types of VCC
VCCs can be set up either as a standalone fund or as an umbrella fund with multiple sub-funds. In the umbrella structure, several CIS can be gathered together under the umbrella of a single corporate entity. The sub-funds so gathered together under a single umbrella may have different investment objectives, investors as well as assets and liabilities, therefore, creating separate compartments within the VCC. There is a separation of assets and liabilities of each sub-fund under this structure, this indicates that investors of a particular sub-fund will be completely unaffected by the performance of another sub-fund. The liabilities incurred by a sub-fund must be discharged solely from the assets of that sub-fund and the assets of that sub fund cannot be used to discharge the liabilities of any other sub fund of the VCC.
This arrangement creates economies of scales as the structure allows the sub-funds to have a common board of directors and have the same service providers like the fund managers. The sub-funds under the umbrella structure are not separate legal entities. Only the VCC is required to be a separate legal entity. The sub-funds are not required to perform certain administrative functions which could save their costs and hence, help them to reap economic benefits. Each sub-fund must be wound up separately to ensure that the ring-fencing of each sub-fund’s assets and liabilities applies during insolvency.
VCC is the latest investment fund innovation in which it can issue and redeem shares without prior approval of the shareholders as required in the Companies registered under the CA. The shares so issued and redeemed must be at their net asset value. This provision is brought into picture to protect the interests of the creditors. The closed-ended funds, which are listed on securities exchange, will be issued and redeemed in accordance with applicable listing requirements and hence, they need not be issued or redeemed at their NAV.
The VCC structure provides the redemption of shares at the option of the investors, in case of open-ended funds, giving them an exit opportunity as and when they wish to. In case of closed-ended funds, the option of redemption is with the CIS. In case of companies registered under CA, there are restrictions on capital reduction and it can be complex for CIS to follow them. Therefore, under this structure they can freely redeem their shares.
Further, the VCC is allowed to pay dividends using its capital unlike the Companies registered under CA, which are allowed to pay dividend only out of their profits.
The financial statements of the sub-funds of the VCC shall be kept separate in order to ensure proper segregation of assets and liabilities and as per the applicable accounting standards. The Bill further proposes that the funds would be allowed to use IFRS and US GAAP to prepare their financial statements. This ensures that the VCC caters the needs of the investors globally and will not be restricted to the jurisdiction where their fund managers, investors or assets are based.
Can this model be replicated in India?
Singapore is not the first country to introduce the concept of variable capital companies. Many other leading fund jurisdictions like Luxembourg, the Republic of Ireland and the United Kingdom has already established such type of companies. Now, since our area of operation is India, it is important for us to understand if this can be replicated in India or not.
The first thing to be noted is that, presently, there is no CIS operating in India. The CIS sector is being viewed with suspicion because of large number of scams reported in this sector. CIS in India is regulated by the Securities Exchange Board of India (SEBI). Every CIS in India has to register itself with SEBI and must involve a corpus of a prescribed amount. It cannot issue and redeem shares without taking prior approval. A detailed mechanism has been prescribed to properly run a CIS and the same is contained in the SEBI (Collective Investment Schemes) Regulations, 1999. SEBI in its regulations has prescribed the conditions to be followed prior making a CIS to instil confidence of the contributor and maintain more transparency in the operation of the scheme. Further, the concept of variable capital companies, if introduced in India, will not fit into the existing regulatory framework. The structure of VCC will decrease the power of SEBI to regulate and supervise CIS which in turn, would lead to increase in illicit activities in India.
Further, we may note that the main reason behind no CIS operating in India is the large amount of restrictions imposed on them. If the concept of VCC is introduced in India, then a CIS may get operational flexibility which may increase its operations in India.
Next, whether this structure be used in other investment structures namely, Mutual Funds, Alternative Investment Funds, Real Estate Investment Trusts or Infrastructure Investment Trusts? Currently, all these are set up in trust form and the funds are raised through issuance of units as the corporate structures do not allow easy exit to the investors. VCCs can bring a revolutionary change in the way investments are made by these investment structures in India. For instance, currently, the mutual fund houses in India have to float separate trusts for each funds to achieve bankruptcy remoteness; under the VCC structure, this can be achieved under one single roof, thereby reducing a lot of operational complexities.
However, introduction of such a class of company will require major rejig in the current regulatory framework. First and foremost, the Companies Act, 2013 will have to be amended to facilitate this class of company. Changes will also have to be made in the Insolvency and Bankruptcy Code so as to allow bankruptcy remoteness to each of the sub-funds. Changes will have to be made in the Income Tax Act so as to treat these at par with the investment trusts and allow the privileges that the investment trusts currently enjoy to this class of company. Lastly, changes will have to be made in the SEBI regulations as currently the various investment trusts are regulated by the SEBI.
The restrictions in the CA impede the normal operations of a CIS which requires flexibility to operate. To overcome these restrictions and to liberalise the regulatory framework, MAS have come out with the concept of VCC in Singapore. The proposed framework takes into consideration the regulations made to govern similar companies in other jurisdictions.
This Bill provides for companies domiciled in other jurisdictions with structures similar to VCC to re locate them in Singapore. This will increase the investment funds in Singapore as the fund managers will be encouraged to re domicile their funds in other jurisdictions with their funds in Singapore. The existing funds in offshore jurisdiction will convert themselves into the VCC incorporated in Singapore.
This proposed framework is expected to increase the investment funds incorporated as investment companies in Singapore and further expected to strengthen the Singapore’s position globally as an investment fund management centre.
If the concept is introduced in India, this will certainly change the way the investments have been made so far, and hopefully the changes will be on a positive note.