SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2021: Synopsis

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Securities Exchange Board of India (SEBI) in its Board Meeting on March 25, 2021 had approved the proposal to amend the extant SEBI (Alternative Investment Funds) Regulations, 2012 (‘Regulations’) in order to meet the following objectives:

  • 1. Providing a definition of ‘startup’ with as outlined by Government of India (GOI).
  • 2. Removal of negative list of activities or sectors from the definition of Venture Capital Undertaking (VCU).
  • 3. Permitting AIFs & Fund of AIFs to invest in units of other AIFs & directly in securities of investee companies.
  • 4. Clarifying scope of responsibilities of Managers & members of Investment Committees
  • 5. Prescribing a Code of Conduct for AIF, Trustee & Directors of the Trustee / Designated Partners / Directors of the AIF, Manager, members of Investment Committee and key management personnel of AIF and Manager.

Accordingly, SEBI vide its notification dated May 5, 2021, introduced the SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2021 (‘Amendments’). Here’s a brief analysis of some key amendments brought in:

I. Revamp for Startup & VCU funding

The amendments introduced definition for startups opening an investment avenue for private limited companies and limited liability partnerships fulfilling criteria for startups as outlined by the Department of Promotion of Industry and Internal Trade (DPIIT) or such other policies of central government issued from time to time. The DPIIT vide its notification dated February 19, 2019 had outlined the following criteria for considering an entity as a startup:

  • 1. Up to a period of 10 years from the date of incorporation / registration.
  • 2. Turnover of the entity for any of the financial years since incorporation/ registration has not exceeded INR 100 Crore.
  • 3. Entity is working towards innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation.

For VCUs as well, the amendments had a huge favorable impact with the introduction of a more inclusive revised definition & doing away with the negative list of activities prescribed for VCUs in erstwhile definition. The revision has brought the likes of NBFCs, gold financiers & entities carrying out activities not permitted by industrial policy of GOI – under the positive list of investment opportunities for Venture Capital Funds (VCFs).

Given the current strain on economy owing to the ever growing onset of Covid-19 pandemic & considering the pivotal role played by Startups & VCUs in boosting employment & innovation in product manufacturing & service rendering, the amendments have bestowed the two sectors with a sigh of relief by providing a regulatory catalyst to flow of funds from AIFs, Angel Investors & & Venture Capital Funds (VCFs).

II. Inter AIF flow of funds

The amendments further allow AIFs to invest in units of other AIFs of same sub-category or lower category alongside erstwhile permitted investment options. Pursuant to amendments, Category III AIFs can now invest in units of other AIFs & complex or structured products alongside securities of listed or unlisted companies & derivatives. Category II AIFs are now allowed to invest in units of Category I & Category II AIFs in addition to primary investment in unlisted companies directly or through investment in units of other AIFs. Lastly, Category I AIFs can invest in units of Category I AIFs of same sub-category besides investee companies, VCUs, special purpose vehicles (SPVs) & LLPs.

Further, AIFs are now permitted to invest in associates or units of AIFs managed or sponsored by the investing AIFs Manager, Sponsor, or associates of its Manager or Sponsor. This is subject to consent of 75% of investors by value of the investing AIF.

The amendments, while allowing a 2 level investment structure, has restricted AIFs authorized to invest in units of other AIFs from offering their units for subscription to other AIFs.

III. Investee Exposure Limits

The amount of exposure an AIF has to a specific investee company is now to include exposure derived through investment in units of other AIFs in addition to direct investments made. Ergo, Category I & Category II AIFs shall now invest not more than 25% of investible funds, either directly or through investments in other AIFs. Similarly, Category III AIFs are permitted to invest not more than 10% of investible funds in an investee company through either of the routes.

IV. Other Amendments

AIFs are now required to include in placement memorandum all material information for the terms of reference of the committee constituted for approving the decisions of the AIF. In order to ensure transparency with all stakeholders, SEBI has introduced amendments revising regulation 20 which outlines general obligations & responsibilities. Furthermore, SEBI has introduced Fourth Schedule specifying the ‘Code of Conduct’ to be adhered to by AIFs, managers, key managerial personnel (KMP) of Manager & AIF, members of investment committee, trustee, trustee company, directors of the trustee company & directors or designated partners of the AIF.

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