INTRODUCTION
In a move to fasten the pace of the investment vehicles in India and provide for a robust a mechanism for streamlining the investment opportunities with that of the market dynamics, the Securities and Exchange Board of India (‘SEBI’), on August 6, 2024 has introduced a significant change to the regulations governing the Alternative Investment Funds (‘AIFs’) with the release of the Alternative Investment Funds (Fourth Amendment) Regulation, 2024 (‘Amendment’)[1]. The amendment primarily focuses on revising the tenure for category I and II AIFs, which are crucial for the growth and regulation of the investment vehicles in India. Based on this precept, this article provides a comprehensive analysis of the key changes, the previous guidelines and the objective behind this Amendment.
BACKGROUND OF AIFs
AIFs represents a significant evolution to the investment landscape of India, providing for a structured framework for pooling capital from various investors and deploying it across asset classes. These funds are distinct from the traditional investment avenues like the mutual funds and portfolio management, and instead focus on alternative asset classes like private equity, venture capital, hedge funds and real estate. SEBI regulations categorize AIFs into three distinct categories, namely:
- Category I AIFs: Funds that invest in start-ups, small and medium enterprises (‘SMEs’) and other sectors that the government considers to be beneficial for the economy.
- Category II AIF: These funds do not fall into the category I or III and typically invest in equity and debt securities.
- Category III AIFs: These funds employ complex strategies which are deployed to generate short-term returns, and would include hedge funds and other similar investment vehicles, wherein no government concession is provided in these forms of investments.
Prior to the Amendment, the tenure of category I and II AIFs were fixed and typically rigid, and the funds were required to adhere to the stipulated timeline for investment and divestment, in a view to inter alia attain investor protection, market stability and encouragement over long-term investments.
| Sr. No. | Aspect | Previous Regulation | Amendment | Analysis |
| 1 | Tenure of category I AIFs | Fixed tenure of 5 years with a possible extension of 2 years. | Allows large value funds for accredited investors to extend their tenure up to 5 years with the approval from the two-third of the unit holder. | This allows for greater flexibility in the fund management, for longer investment horizons. |
| 2 | Tenure of Category II AIFs | Fixed tenure of 5 years. | Similar to category 1, with the extension up to 5 years with the approval from two-third of the unit holder. | The change offers more leeway for fund managers to execute long-term strategies, allowing a further extension up to 10 years. |
| 3 | Borrowing Limits | Limited to 30% of the corpus for category II AIFs. | Limits category I AIFs from borrowing funds, except to meet temporary funding requirements on day-to-day operational requirements for not more than 30 days, not exceeding 10% of the investible funds, and on not more than four occasions in a year. Further, it restricts borrowing for category II AIFs similarly. | The new regulation clarifies the borrowing limits and conditions, emphasizing temporary funding. |
| 4 | Investment Restrictions | Strict guidelines on the types of investment allowed. | Under the Amendment, category I and II AIFs are allowed to create encumbrances in the nature of lien or mortgage on the equity holding in investee companies that operate in the infrastructure sector, specifically for the purpose of borrowing by such investee companies over its projects. | This change allows a company to create encumbrances for the investee company, offering to borrow funds, as earlier AIFs were not allowed to create encumbrances for their own borrowing.Hence this allows the investee company to borrow funds against the encumbered equity, which then could be used for the purpose of the company’s infrastructure projects. |
CONCLUSION
The Amendment introduced by SEBI reflects the concerted effort to streamline the operational efficiency of the AIFs and ensures that the investors protection and market dynamics are in sync to create an optimum level of production. The underlying aspects viz a vi increase the tenure for category I and II AIFs beyond 5 years, setting a cap on the temporary borrowing limit over investable funds and allowing for investee company to borrow more funds by creating an encumbrance over its equity holding suggests that robust actions have been taken to create interest of investors over AIF and to further provide operational flexibility over its working.
[1] Security and Exchange Board of India, “Securities and Exchange Board of India (Alternative Investment Funds) (Fourth Amendment) Regulations, 2024”, August 6th 2024. Available at: https://www.sebi.gov.in/legal/regulations/aug-2024/securities-and-exchange-board-of-india-alternative-investment-funds-fourth-amendment-regulations-2024_85550.html
