National Law Institute University,

Bhopal

LBA-III ( Law of Securities)

Trimester- IX

PROJECT ON

Alternative Investment Funds

SUBMITTED TO:

PROF. (Dr.) J. Kondaiah

SUBMITTED BY:

Vedant Malviya (2013 BALLB 10)

1 |A l t e r n a t i v e I n v e s t m e n t F u n d s
 Introduction
Alternative Investment Funds (AIFs) are basically funds established or incorporated in India for
the purpose of pooling in capital from Indian and foreign investors for investing as per a pre-
decided policy.

In other words, anything alternate to traditional form of investments gets categorized as

alternative investments. Now, what is considered as traditional may vary from country to
country. Generally, investments in stocks or bonds or fixed deposits or real estates are considered
as traditional investments. However, even with respect to investments in stocks, if the
investments are in the stocks of small and medium scale enterprises (SMEs), it gets categorized
as alternative investments in many jurisdictions (For instance, the SME exchange is called as
Alternative Investment Market (AIM) in UK). Generally, the term AIF refers to private equity
and hedge funds.

History of AIF Regulationin India

SEBI (Venture Capital Funds) Regulations (“VCF Regulations”) were framed in 1996 to
encourage funding by entrepreneurs’ early-stage companies in India. However, over the years,
the Venture Capital Funds (VCF) route was being used by several other funds including Private
Equity (PE) funds, Real Estate funds, etc. This made it difficult to target concessions and
incentives specific to VCFs without enabling other funds to avail of such incentives or
concessions. Further, the investment restrictions placed on VCFs were not suitable for such
funds. Hence, on one hand, there were a set of funds like VCF which required incentives and
concessions and were comfortable with consequent restrictions attached and on the other hand,
there were another set of funds like PE funds which did not require incentives and concessions
but required investment flexibility.

Further, since registration of VCF was not mandatory under VCF Regulations, all players in the
alternative funds industry were not registered with SEBI. Hence, there was a regulatory gap
which needed to be addressed.

2 |A l t e r n a t i v e I n v e s t m e n t F u n d s
The SEBI Board, in its meeting held on July 28, 2011, while considering the agenda on “Plan of
Actions for Compliance To Eight New IOSCO Objectives and Principles of Securities
Regulation”, approved the proposal for a clear regulatory framework for private pools of capital
which may, inter-alia, provide for a mechanism to monitor and assess systemic risks and risks to
financial market stability posed by the activities of such funds.

Taking into consideration the above, SEBI proposed a Regulatory framework for Alternative
Investment Funds on August 1, 2011 through the concept paper placed on SEBI website along
with the draft AIF Regulations which was kept open for public comments till August 30, 2011.
Through this concept paper, SEBI proposed to regulate all funds established in India which are
private pooled investment vehicles raising funds from Indian or foreign investors, excluding
Mutual Funds and Collective Investment Schemes registered with SEBI. Further, any such pool
of funds which is regulated by any other regulator in India like banks, pension funds, etc. was
also proposed to be excluded from the purview of the proposed Regulations.

Based on the public comments, the revised Regulations were submitted for the approval of the
SEBI Board in its meeting held on 2ndApril 2012. The final Regulations were issued on 21 May
2012.

The AIF Regulations is an attempt to extend the perimeter of regulation to hitherto unregulated
funds, so as to ensure systemic stability, increase market efficiency, encourage formation of new
capital and provide investor protection.

Alternative Investment Funds- Definition

In India, alternative investment funds (AIFs) are defined in Regulation 2(1)(b) of Securities and
Exchange Board of India (Alternative Investment Funds) Regulations, 2012. It refers to any
privately pooled investment fund, (whether from Indian or foreign sources), in the form of a trust
or a company or a body corporate or a Limited Liability Partnership(LLP) which are not
presently covered by any Regulation of SEBI governing fund management (like, Regulations
governing Mutual Fund or Collective Investment Scheme)nor coming under the direct regulation
of any other sectoral regulators in India-IRDA, PFRDA, RBI. Hence, in India, AIFs are private
funds which are otherwise not coming under the jurisdiction of any regulatory agency in India.

3 |A l t e r n a t i v e I n v e s t m e n t F u n d s
Thus, the definition of AIFs includes venture Capital Fund, hedge funds, private equity funds,
commodity funds, Debt Funds, infrastructure funds, etc.,while, it excludes Mutual funds or
collective investment Schemes, family trusts, Employee Stock Option / purchase Schemes,
employee welfare trusts or gratuity trusts, ‘holding companies’ within the meaning of Section 4
of the Companies Act, 1956, securitization trusts regulated under a specific regulatory
framework,and funds managed by securitization company or reconstruction company which is
registered with the RBI under Section 3 of the Securitization and Reconstruction of Financial
Assets and Enforcement of Security Interest Act, 2002.

One AIF can float several schemes. Investors in these funds are large institutions, high net worth
individuals and corporates.

Types of AIFs

AIFs are categorized into the following three categories, based on their impact on the economy
and the regulatory regime intended for them:

 Category I AIF are those AIFs with positive spillover effects on the economy, for which
certain incentives or concessions might be considered by SEBI or Government of India;
Such funds generally invests in start-ups or early stage ventures or social ventures or
SMEs or infrastructure or other sectors or areas which the government or regulators
consider as socially or economically desirable. They cannot engage in any leverage
except for meeting temporary funding requirements for not more than thirty days, on not
more than four occasions in a year and not more than ten percent of the corpus.eg.
Venture Capital Funds, SME Funds, Social Venture Funds and Infrastructure Funds.
Giving effect to the announcement by Union Finance Minister on angel investor pools in
the Union Budget 2013-14, SEBI in June 2013 has approved a framework for registration
and regulation of angel pools under a sub- category called 'Angel Funds' under Category
I- Venture Capital Funds.

 Category II AIF are those AIFs for which no specific incentives or concessions are
given. Theydo not undertake leverage or borrowing other than to meet the permitted day
to day operational requirements, as is specified for Category I AIFs. eg. Private Equity or
debt fund.

4 |A l t e r n a t i v e I n v e s t m e n t F u n d s
  Category III AIF are funds that are considered to have some potential negative
externalities in certain situations and which undertake leverage to a great extent; These
funds trade with a view to make short term returns. These funds are allowed to invest in
CateogyI and II AIFsalso. They receive no specific incentives or concessions from the
government or any other Regulator.eg. Hedge Funds (which employs diverse or complex
trading strategies and invests and trades in securities having diverse risks or complex
products including listed and unlisted derivatives).

Fund raising and investment restrictions for AIFs

AIFsraise funds through private placement and they cannot accept from an investor an
investment of value less than Rs. 1 Cr. The fund or any scheme of the fund cannot have more
than 1000 investors and each Scheme should have a corpus of Rs. 20 Crore.The manager or
sponsor/ promoterof the AIF should have a continuing interest in the AIF of not less than 2.5%
of the initial corpus or Rs.5 crore whichever is lower.

AIFs of Category I and II are not permitted to invest more than 25% of the investible funds in
one Investee Company while it is 10% for Category III AIFs.

Units of close ended AIFs are allowed to be listed on a stock exchange (but only after final close
of the fund or scheme) subject to a minimum tradable lot of 1Crore rupees.

All AIFs are required to comply with the reporting norms to SEBI on a quarterly basis (for
Category I, II AIFs and for those Category III AIFs which do not employ leverage) or on a
monthly basis (for Category III AIFs which employ leverage). The reporting formats and the
method of reporting is specified in the circular dated July 29, 2013.

Category III AIFs also have to additionally comply with norms pertaining to risk management,
compliance, redemption and leverage as specified in the circular. The leverage for a Category III
AIF is specified not to exceed 2 times i.e. the gross exposure after offsetting for hedging and
portfolio rebalancing transactions should not exceed 2 times the NAV of the fund.

5 |A l t e r n a t i v e I n v e s t m e n t F u n d s
SEBI revises guidelines for alternative investment funds

To usher in more transparency, capital market regulator SEBI has revised certain guidelines for
alternative investment funds, including stricter disclosure requirements.

Alternative Investment Funds (AIFs) are basically funds established or incorporated in India for
the purpose of pooling in capital from Indian and foreign investors for investing as per a pre-
decided policy.

It has been decided to “provide certain clarifications on the AIF regulations, increase
transparency to the investors and provide reporting norms for AIFs,” the Securities and
Exchange Board of India (SEBI) said in a circular on Thursday.

SEBI has asked all AIFs to disclose the “disciplinary history” of the fund, its sponsor, manager,
directors, partners, promoters and associates. The details should be included in the AIF’s
placement memorandum.

These funds are required to provide details of pending and past cases (where the person has been
found guilty) of litigations, criminal or civil prosecution, disputes and non-payment of statutory
dues, among others.

“In case of operational actions such as administrative warnings/deficiency letters, the same may
be grouped together and summarised. However, if the investor seeks details of the summarised
portion, the same shall be provided by the AIF to the investor,” the circular said.

Existing AIFs are required to send these details to their investors within 30 days. Meanwhile
SEBI has relaxed the reporting requirement for Category III AIFs with respect to their daily
exposures.

Category-III AIFs are those trading with a view to making short-term returns and it includes
hedge funds.

Modifying a previous circular, issued in July 2013, SEBI said that all Category III AIFs shall
report to the custodian the amount of leverage at the end of the day (based on closing prices) by
the end of next working day.

Currently, this category of AIFs are required to give the details to the custodian on the same day
itself.

6 |A l t e r n a t i v e I n v e s t m e n t F u n d s
“It has been observed that with respect to reporting of amount of leverage at the end of the day,
the AIF is dependent on various parties in order to calculate and submit to the custodian the
amount of leverage at the end of the day. Such various parties provide information at varied time
periods due to which the AIFs are finding it difficult to report to the custodian the amount of
end-of-day leverage on the same day,” the latest circular said.

Among others, AIFs are required to intimate SEBI within two days of receiving request for
redemption from the client.

Conclusion

AIF’s includes venture Capital Fund, hedge funds, private equity funds, commodity funds, Debt
Funds, infrastructure funds, etc.,while, it excludes Mutual funds or collective investment
Schemes, family trusts, Employee Stock Option / purchase Schemes, employee welfare trusts or
gratuity trusts, ‘holding companies’ within the meaning of Section 4 of the Companies Act,
1956, securitization trusts regulated under a specific regulatory framework, and funds managed
by securitization company or reconstruction company which is registered with the RBI under
Section 3 of the Securitization and Reconstruction of Financial Assets and Enforcement of
security Interest Act, 2002.

7 |A l t e r n a t i v e I n v e s t m e n t F u n d s