Investment advisors and research analysts, including the unregistered ones have been on SEBI’s radar for quite some time. As per latest data available on SEBI’s website (30th September, 2024), there are 953 Investment Advisors1 and 1358 Research Analysts2 registered with SEBI. Following the consultation paper on review of regulatory framework for investment advisors and research analysts SEBI, in its Board meeting on 30th September, 2024, has approved many of these proposals. While some proposals are aimed at an ease of registration for an entity/ person as an RA/ IA, the CP also contained substantial proposals w.r.t. the activities and functioning of IAs and RAs.
In this article, we discuss the broad concept of IAs and RAs and a few major proposals under the CP, with our analysis on the potential implications. The fine text of the Amendment Regulations is awaited, for getting the necessary clarity on the position of IAs and RAs, pursuant to the revised regulatory framework.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Team Finservhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngTeam Finserv2024-08-09 20:02:122024-10-01 18:47:39Research Analysts v/s Investment Advisors - Is the Line Blurring ?
The Union Budget 2024 refers to permitting a flexible mode for financing leasing of aircrafts and ships, and pooled funds of private equity through a variable capital company (VCC) structure. Variable Capital Companies (VCCs), as the name suggests, are companies in which the capital is not static, that is to say, the investor has the option to withdraw capital based on the satisfaction of certain conditions. In a traditional company form of entity, the capital is static, and any reduction in capital (except buyback upto a specified extent), attracts specific procedure, including most importantly, approval from NCLT and other regulatory/ statutory authorities.
Globally, similar structures exist in various countries, known by different names, such as – Variable Capital Companies in Singapore and Mauritius, Open Ended Investment Companies (OEIC) in the UK, and a specific form of collective asset management companies in Ireland and Luxembourg.
In the context of India, the discussions around VCC are not new, the IFSCA has been exploring opportunities to bring a legislative framework for incorporation of the VCC form of entity. In fact, an Expert Committee, under the Chairmanship of Mr M S Sahoo, had released a report providing recommendations for bringing a legal framework for VCCs in IFSC in October, 2022.
What are VCCs?
VCCs are a relatively new form of corporate structure, an investment vehicle housing multiple funds under one entity, while ringfencing the asset pools of each sub-fund distinctly – like a Protected Cell Company (PCC).
In jurisdictions such as Mauritius, the VCC has an option to elect to have a separate legal identity for each of its sub-fund, however, the same would require each sub-fund to be incorporated as a separate company. Even if the sub-funds are not incorporated as separate legal entities, their properties remain distinct from the umbrella fund (VCC) and any liability attributable to a specific fund is discharged solely from the assets of such a sub-fund.
Most importantly, as the name suggests, these structures have a flexibility on pay-outs to the investors. Such flexibility is provided in the form of permitting redemption of the shares of the fund at any time at a price related to the net present value of the scheme property, subject to the shares being fully paid-up.
Introduction of VCCs in IFSC
The Report recommended VCC structure to be first introduced in IFSCs owing to the preparedness of international players in dealing with such structures since VCC structures are already existent in various other jurisdictions. Based on the functioning of the VCC-structure in IFSCs, the same may be subsequently introduced in the domestic Indian financial system too.
Regulatory framework for VCCs in IFSC
Under the IFSC regulatory ecosystem, VCCs are proposed to be recognised under the IFSCA Act, 2019. Additionally, the activities of the VCC should be governed by the IFSCA (Fund Management) Regulations, 2022.
The Report suggests a VCC to be incorporated as a company, and the sub-funds thereof to derive their character from the VCC instead of being recognised as separate legal persons. There is a segregation of assets and liabilities at each sub-fund level, and as such, each sub-fund is bankruptcy remote from the insolvency proceedings initiated against another sub-fund.
Conditions w.r.t. “variability” of capital in VCC
Unlike a company which has a fixed paid-up capital, in case of a VCC, the paid-up capital, at all times, reflects the value of the net assets of the VCC.
The Report suggests VCCs may raise funds in both equity and debt form, issuing different classes of equity and debt securities to represent the interest of the holder in the specific sub-fund to which the securities relate to. The Report also proposes the introduction of “management shares” and “participating shares”, similar to the concept already prevalent in Singapore.
The recommendations suggest redemption of participating shares, carrying economic rights, at the net asset value of the scheme, subject to the shares being fully paid-up. On the other hand, for management shares, containing voting rights, the same is proposed to be irredeemable, however, the VCCs should have an option to buyback such shares with requisite approvals and following due procedure.
In view of the flexibility that VCC provides, the structure is getting increasingly popular. In Singapore, since the launch of provisions around VCCs in 2020 vide the Variable Capital Companies Act, 2018 in January, 2020, a total of 969 VCCs have been incorporated till 2022, representing around 2000 sub-funds.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Team Corplawhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngTeam Corplaw2024-07-12 12:08:522024-07-12 13:52:10Stock brokers to detect mule accounts, set up systems to detect fraud and market abuse
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00surabhichurahttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngsurabhichura2024-07-09 18:22:032024-07-12 12:44:51SEBI eases investing norms for NRIs, OCIs, and RIs through FPI route in IFSC
Policies have become a regulatory necessity in many cases. The Companies Act and Listing regulations require several policies: for example, nomination and remuneration policy, CSR policy, whistle blower policy, policy for determination of material subsidiary etc.
The RBI’s regulations require policies every now and then – an indicative list of policies needed by NBFCs (for base layer and middle layer) is here
RBI regulations for banks require an even larger list of policies. An indicative list of policies for banks can be accessed here.
To conclude: policies are needed for companies in many respects/fields.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Team Corplawhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngTeam Corplaw2024-05-20 16:54:482024-05-23 15:36:54Online workshop on Verification of Market Rumour by listed entities and other related amendments
SEBI had raised concerns relating to evergreening of loans, circumvention of FEMA norms, QIB regulations and other concerns on regulatory arbitrage by Alternative Investment Funds (‘AIFs’) in its Consultation Paper issued in January, 2024. SEBI also recorded 40+ cases wherein the structure of AIF had been abused and used to circumvent extant financial sector regulations. Read our analysis in the article ‘AIFs ail SEBI: Cannot be used for regulatory breach’ dated January 31, 2024. Further, RBI had also barred all regulated entities (REs) with respect to their investments in AIFs, discussed in our article.
Subsequent to receipt of public comments, the proposal to mandate due-diligence (‘DD’) of investors and each of the investments made by the AIF was approved in the SEBI Board meeting held on March 15, 2024. SEBI notifiedSEBI(Alternative Investment Funds) (Second Amendment) Regulations, 2024 effective from April 25, 2024 amending Reg. 20 of the SEBI (Alternative Investment Funds) Regulations, 2012 (‘AIF Regulations’) dealing with general obligations thereby requiring every a. AIF, b. investment manager of the AIF, c. KMP of the AIF, and d. KMP of the investment manager, to exercise specific DD with respect to their investors and investments in order to prevent facilitation of circumvention of such laws as may be specified by SEBI from time to time.
The list of laws, thresholds and conditions for DD, reporting requirements etc. has been provided in SEBI circular dated Oct 8, 2024 (‘SEBI Circular’). DD is required to be carried out prior to making of investments as per implementation standards formulated by Standard Setting Forum for AIFs (‘SFA’) and published on websites of the industry associations which are part of the SFA, i.e., Indian Venture and Alternate Capital Association (‘IVCA’), PE VC CFO Association and Trustee Association of India.
Scope of laws covered under the ambit of due diligence
The list of laws provided in the SEBI Circular comprises of the following:
Provisions of SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018 (‘ICDR Regulations’), and other regulations of SEBI wherein benefits or relaxations have been provided to entities designated as Qualified Institutional Buyers (‘QIBs’).
Provisions of the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (‘SARFAESI Act’) wherein benefits are provided to entities designated as Qualified Buyers (‘QBs’).
Prudential norms specified by RBI for regulated lenders with respect to Income Recognition, Asset Classification, Provisioning and restructuring of stressed assets;
Rule 6 of FEMA (Non-Debt Instruments) Rules, 2019 (NDI Rules) for investment from countries sharing land border with India ( read with Press Note 3 dated April 17, 2020 of FDI Policy 2020)
Timing, thresholds for DD, reporting requirements
Pursuant to the SEBI Circular, the due diligence for various investors and investments is required to be carried out by a. AIF, b. investment manager of the AIF, c. KMP of the AIF, and d. KMP of the investment manager in accordance with the Implementation Standards. The table below indicates in brief the criteria, checkpoints and timelines for conducting due diligence along with the consequences of the outcome.
Sr. No
Objective intended to be achieved by investors through investments in AIF scheme
Regulations/ Directions/ Norms applicable
Applicability of requirement of DD for every scheme of AIF (refer Note 1)
Checkpoints for manager for specific DD
Timing of DD
Consequence of outcome of DD & reporting requirements, if any
1
Benefits designated for QIBs
ICDR and other SEBI Regulations
If an investor, or investors belonging to the same group, contribute(s)50% or more to the corpus of the scheme.
Manager to check if such if investor/ investors of the same group is/are:(i) QIBs themselves or,(ii) Entities established, owned or controlled by the Central Government or a State Government or the Government of a foreign country, including central banks and sovereign wealth funds.Note: Where such investor is an AIF or fund set up in IFSC or outside India, above check to be carried out on a look through basis.
Prior to availing benefits available to QIBs
Refer Note 2 below for existing investments & Note 3 for proposed investments.Manager to provide confirmation to SE or lead manager or merchant banker on this.
2
Benefits designated for QBs
Under SARFAESI Act
If an investor, or investors belonging to the same group, contribute(s)50% or more to the corpus of the scheme.
Same as above
Prior to making any investments or availing benefits
Refer Note 2 below for existing investments & Note 3 for proposed investments.
RBI norms on Income Recognition, Asset Classification, Provisioning and Restructuring of stressed loans/ assets
(a)whose manager or sponsor is an entity regulated by RBI; or,(b)that has investor(s)regulated by RBI who:(i)individually or along with investors of the same group contribute(s) 25% or more to the corpus of the scheme; or(ii) is an associate of the manager/ sponsor of the AIF;(iii) has majority or veto power [by itself, or through its representatives/ nominees] in voting over decisions of the investment committee set up by the manager to approve investment decisions of the scheme.Note: where investor is an AIF or fund set up in IFSC or outside India, criteria check to be carried out on a look through basis.
Refer Note 4.
Prior to making any investments, to avoid indirect investment by RBI regulated lender/ entity.
Refer Note 2 below for existing investments & Note 3 for proposed investments.
4
Investment from countries sharing land border with India
FEMA (NDI) Rules, 2019
Where 50% or more of the corpus of the scheme is contributed by investors (a)who are citizens of/are from/are situated in a country which shares land border with India; or(b)whose beneficial owners, as determined in terms of Rule 9 (3) of the PMLA (Maintenance of Records) Rules, 2005, are citizens of/are from/are situated in a country which shares a land border with India.
If the proposed investment would result in the scheme holding 10 % or more of equity/equity-linked securities issued by the company (on a fully-diluted basis), the manager to check details stated in the previous column, by collecting information on the country of investors and their beneficial owners.
Prior to making any investment
Refer Note 2 below for existing investments & Note 5 for proposed investments.
Note 1: same group’ shall mean ‘related parties’ and ‘relatives’ as defined in SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015.
Note 2:
For Sr nos 1 to 3: DD requirement is applicable for existing investments too, held by AIF schemes as on October 8, 2024:
If DD check not satisfactory – details of investment to be reported to AIF’s custodian on or before April 07, 2025, in the format as per Annexure 1 of the circular;
If DD check satisfactory – AIF manager to submit an undertaking to AIF’s custodian on or before April 07, 2025.
For Sr no. 4: Reporting is required to be made for existing investments held by AIF schemes as on October 8, 2024 if the scheme holds 10% or more of equity/ equity-linked securities on a fully-diluted basis, to AIF’s custodian on or before April 07, 2025 in the format prescribed by SFA.
Note 3:
Consequence of not satisfying requirements of DD checks specified by SFA for proposed investments in case of Sr nos 1 to 3:
Such investor or investor group to be excluded along with necessary disclosure in the private placement memorandum (PPM); or
Investment cannot be made.
Note 4:
Note 5: Details of investment, which would result in the scheme holding 10% or more of equity/ equity-linked securities on a fully-diluted basis, to be reported to the custodian within 30 days of investment, in the below format specified by SFA.
DD requirement – one-time or ongoing?
As discussed in the SEBI BM Agenda, the purpose of the due-diligence check is to prevent facilitation of any circumvention of provisions of financial sector regulators, which cannot be a time specific check. An entity who intends to circumvent can design the structure in such a way that, at a later date post investment, it acquires the units of AIFs post investment, such as buying the units of an existing investor or by acquiring control over the existing investor entity, as per prior arrangement. Accordingly, it has been indicated that due diligence around investors and investments will be an ongoing one.
Applicability of DD – prospective or retrospective?
As per the SEBI circular this is applicable for existing and prospective investments. Refer Note 2 above.
Obligations of Custodian to the AIF
Information received from AIFs under Note 2 to be furnished to SEBI on or before May 7, 2025.
Information received from AIFs in terms of Note 4 above on a monthly basis to be compiled and reported to SEBI within 10 working days from month end.
Power of AIF to exclude an investor
As per SEBI Circular, in cases where the outcome of DD is not satisfactory, in that case the AIF will either have to exclude the investor or investor group or abstain from making the proposed investment.
Figure 1: Circumstances to excuse an investor of AIF
Conclusion
The present amendment and SEBI Circular lays an onerous burden on the AIF, manager and KMP of the AIF and the manager. The DD requirement has become effective from October 8, 2024 and applies to existing investments as well. The AIFs have an actionable of evaluating the existing investments in the scheme in the light of the present amendment and ensure reporting in next 6 months. The obligation of on-going due diligence will result in a compliance burden, but is justified given the intent of law as “quando aliquid prohibetur ex directo, prohibetur et per obliquum” i.e. things that cannot be done directly should not be done indirectly either. AIFs will continue ‘trust, but verify’ using the DD standards for due diligence. The trustee/ sponsor of the AIF is required to ensure that compliance status of this amendment is reported to SEBI in the ‘Compliance Test Report’ prepared by the manager in terms of Chapter 15 of Master Circular for AIFs.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Team Corplawhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngTeam Corplaw2024-05-03 20:07:492024-10-22 15:43:43Trust, but verify: AIFs cannot be used as regulatory arbitrage
The Reserve Bank of India on 19th December 2023 issued a notification[1] imposing a bar on all regulated entities[2] (REs) with respect to their investments in AIFs. We had covered the same in our earlier write-up. The Circular has already created some bloodshed as several banks took a hit in their Q3 results. Though late, yet welcome, the RBI has now come with some relief by a March 27 2023 circular. The following Highlights are based on the original circular, as amended by the March 27th circular :-
What has the RBI done?
Prohibited all regulated entities (REs), including banks, cooperative banks, NBFCs and All India Financial Institutions from making investments in Alternative Investment funds (AIFs), if the AIF has made any investment in a “debtor company”, other than by way of equity shares of the debtor company. Hence, if the AIF has made investment by way of bonds, structured capital instruments, etc., issued by a debtor company, the bar as above will apply.
Debtor company means a company in which the RE currently has or previously had a loan or investment exposure anytime during the preceding 12 months
The bar applies immediately, that is, effective 19th Dec 2023. No further investments to be made.
If investments already exist, the RE shall exit within 30 days, that is, by 18th Jan., 2024. Hindsight clearly shows that for most regulated entities, there was no way to cause exit, as AIF investments are evidently illiquid. Hence, most regulated entities took a hit on their P/L.
Further, if an RE has made an investment in an AIF, and the AIF invests in a debtor company, the RE shall make an exit within 30 days.
Investment by REs in the subordinated units of any AIF scheme with a ‘priority distribution model’ subject to full deduction from RE’s capital funds. See further discussion on priority distribution model below.
What was the intent?
Since several REs have affiliated AIFs, routing the money through AIFs to borrowers might have led to ever greening. That is, the AIF would invest the money into a debtor company, and consequently, the debtor company would keep its account as a performing asset. In essence, the AIF was acting as a stopover in the process of round tripping of the money back to a debtor company, from where it will be used to pay off the lender.
What will be the impact of the Circular?
Most of the larger REs have affiliated AIFs. Flow of funds to them from the RE would stop completely.
The sweep of the circular is wide and non-discriminatory. Not only affiliated AIFs, but any AIF in general will be dried of funding from REs. While the bar is only for those AIFs which have invested in “debtor companies”, it will be practically tough for REs to avoid overlapping investments. Given the severe implications of a breach, compliance-sensitive REs will avoid investing in AIFs.
There is an immediate disinvestment pressure on AIFs, as there may be overlapped investments. AIFs’ assets are mostly illiquid – ensuring exit to RE investors may be tough. In many cases, there are lock-in restrictions as well.
Not only has the RBI expressed concerns, SEBI also issued a consultation paper for enhancement of trust in the AIF ecosystem, citing use of AIFs for regulatory arbitrage. See our write up on the SEBI proposals.
Direct or indirect investments:
As the Circular is driven by concerns of round-tripping, widening the circuit by creating more stop-overs does not help. For example, if a lender invests in an AIF, which invests in an intermediate entity, which in turn invests in a debtor entity, the trail of the money is clear. Likewise, the lender may be making an indirect investment in an AIF.
However, where there is no round-tripping of the money to a “debtor company”, there should be no concern. For example, if a lender makes a loan to an entity, where an AIF of the group has also made investments, there is no flow of money from the lender to the AIF, for the purpose of the downstream investment by the AIF into the debtor company.
Investments through mutual funds and FOFs exempt:
The 27th March circular exempts instances where investments are made by lenders into mutual funds or FoFs, and those in turn have some exposure in either an AIF or in a debtor entity.
Priority distribution model or structured AIFs
In addition to the concerns on downstream investments by AIFs in debtor companies, the RBI also had concerns on the so-called structured AIFs or AIFs with a distribution waterfall. Whether AIFs can at all have a priority distribution waterfall is currently under SEBI examination and SEBI has stopped AIFs from using structured distribution schemes (by way of accepting fresh commitment or making investment in a new investee company) . However, several existing schemes have such models.
If a lender makes an investment in the subordinated units of a structured AIF scheme such investments will get deducted from the regulatory capital of the lender. The March 27 circular now clarifies that the deduction will be equally from Tier 1 and Tier 2 capital. Further, it also clarifies that the subordinated exposures in the AIF schemes could be in the form of subordinated exposures, including investment in the nature of sponsor units.
Concern areas
Ideally, the bar should have been limited to affiliated AIFs. Affiliated AIFs could have been defined appropriately – for example, a related party, or where the investment manager, or sponsor is a related party of the RE. Extending the bar to all AIFs is quite far from the intent of the circular – which is, admittedly, to curb evergreening. It is difficult to see how unrelated AIFs can be used by an RE to evergreen, as investment decisions of these AIFs are not exercised by the investors.
Ideally, the bar should have been limited only to Cat 1 and Cat 2 AIFs. Cat 3 AIFs, widely known as hedge funds, typically play in equity long/short strategies, or do other leveraged trades. REs find such investment a useful way to diversify their funds into hedge funds. Hedge fund investments are common by institutional investors all over the world; an outright curb on these investments by REs is, once again, beyond the stated intent. Notably, given the wide range of investments that Cat 3 AIFs make, avoiding an overlap with the RE’s borrowers will be quite impractical.
Practical implementation of this circular, if at all a RE invests in an AIF, will be quite tough. AIFs will have to share their potential investment list, which will be against any investment manager’s choice. Assuming there is an overlapped investment, the RE will have to exit within 30 days, which will create liquidity issues for AIFs, in addition to challenging the lock-in restrictions.
Most of the regulated entities took a provision in the 3rd quarter. The 27th March circular of the RBI gives some relief by saying that the provision will be required only to the extent of the downstream investment in a debtor entity.
In our view, there is a need to review the regulatory mechanism for AIFs, as currently, AIFs are being used as instruments of regulatory arbitrage.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Team Corplawhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngTeam Corplaw2024-03-17 22:55:342024-03-17 23:17:18SEBI approves uniform approach for market rumour verification, eases on-going compliance requirement for listed companies, eases norms for IPO/ fund raising, AIFs, relaxes requirement for FPI & extends timeline for HVDLE on March 15, 2024
The most reliable way to predict the future is to create it
– Abraham Lincoln
Surely, Lincoln did not have either securitisation or predictability in mind when he wrote this motivational piece; however, there is an interesting and creative use of securitisation methodology, to raise funding based on cashflows which have some degree of predictability. In many businesses, once an initial framework has been created, cashflows trickle over time without much performance over time. These situations become ideal to use securitisation, by pledging this stream of cashflows to raise funding upfront. Surely, traditional methods of on-balance-sheet funding fail here, as there is very little assets on the balance sheet.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2024-03-04 15:46:002024-04-24 16:34:16The Promise of Predictability: Regulation and Taxation of Future Flow Securitization
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