[The following post is contributed
by Nidhi Ladha, who is a Junior Partner at
Vinod Kothari & Co. She can be reached at [email protected]]
by Nidhi Ladha, who is a Junior Partner at
Vinod Kothari & Co. She can be reached at [email protected]]
SEBI
(Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”) were
notified by SEBI on May 21, 2012 which thereby replaced the SEBI (Venture
Capital Funds) Regulations, 1996. After notification of AIF Regulations, SEBI
has granted in principle approval to some 47 AIFs[1]
including 10 category III AIFs. However the existing AIF Regulations (like
Regulations 18 and 28) have given power to SEBI to issue further operational
and reporting guidelines in due course. So after a period of 14 months, SEBI
has come up with additional guidelines on operational and prudential norms for
category III AIF and reporting norms for all categories of AIF vide its
circular CIR/IMD/DF/10/2013 dated July 29, 2013[2]
(“AIF Circular”).
(Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”) were
notified by SEBI on May 21, 2012 which thereby replaced the SEBI (Venture
Capital Funds) Regulations, 1996. After notification of AIF Regulations, SEBI
has granted in principle approval to some 47 AIFs[1]
including 10 category III AIFs. However the existing AIF Regulations (like
Regulations 18 and 28) have given power to SEBI to issue further operational
and reporting guidelines in due course. So after a period of 14 months, SEBI
has come up with additional guidelines on operational and prudential norms for
category III AIF and reporting norms for all categories of AIF vide its
circular CIR/IMD/DF/10/2013 dated July 29, 2013[2]
(“AIF Circular”).
Risk Management and Leverage
conditions for Category III AIFs
Category III consists of those funds
that employ leverage – that is, apart from investors’ unit capital, these funds
may borrow other than for temporary liquidity purposes and may employ
leverage including through investment in listed or unlisted derivatives. Accordingly,
such hedge funds, real estate funds, funds of funds or such other funds which
trade with a view to make short term returns or such other funds which are open
ended and for which no specific incentives or concessions are given by the
government or any other regulator are to be included in this category. As only a
category III AIF is allowed to employ leverage, SEBI is more stringent for such
category of AIF and has issued certain norms governing the leverage by the
category III AIF. Following are some highlights of the AIF circular in this
aspect:
that employ leverage – that is, apart from investors’ unit capital, these funds
may borrow other than for temporary liquidity purposes and may employ
leverage including through investment in listed or unlisted derivatives. Accordingly,
such hedge funds, real estate funds, funds of funds or such other funds which
trade with a view to make short term returns or such other funds which are open
ended and for which no specific incentives or concessions are given by the
government or any other regulator are to be included in this category. As only a
category III AIF is allowed to employ leverage, SEBI is more stringent for such
category of AIF and has issued certain norms governing the leverage by the
category III AIF. Following are some highlights of the AIF circular in this
aspect:
– AIFs to have a
comprehensive risk management framework supported by an independent risk
management function, appropriate to the size, complexity and risk profile of
the fund;
comprehensive risk management framework supported by an independent risk
management function, appropriate to the size, complexity and risk profile of
the fund;
– AIFs to maintain
appropriate records of the trades/transactions performed; and
appropriate records of the trades/transactions performed; and
– AIFs to provide
full disclosure and transparency about conflicts of interest and policy to
manage them. Such conflicts shall be disclosed to the investors in the
placement memorandum and by separate correspondences as and when such conflicts
may arise.
full disclosure and transparency about conflicts of interest and policy to
manage them. Such conflicts shall be disclosed to the investors in the
placement memorandum and by separate correspondences as and when such conflicts
may arise.
With
regard to leverage, SEBI has directed all Category III AIFs to calculate the
leverage as the ratio of the exposure to the Net Asset Value of the AIF and the
AIF is to ensure that the leverage shall not exceed 2 times of the NAV
of the AIF at all times. In addition, SEBI has also provided the
pointers to calculate the NAV of the AIF.
regard to leverage, SEBI has directed all Category III AIFs to calculate the
leverage as the ratio of the exposure to the Net Asset Value of the AIF and the
AIF is to ensure that the leverage shall not exceed 2 times of the NAV
of the AIF at all times. In addition, SEBI has also provided the
pointers to calculate the NAV of the AIF.
Analysis
As category III AIFs are more
exposed to risks and are allowed to borrow outside funds, stringent conditions
for risk mitigation and control should be in place and that is what SEBI has
done. By limiting the amount of leverage and putting certain rigorous
disclosure requirements on breach of leverage, SEBI has tried to provide a
regulatory control over category III AIFs. However, a notable point is that
SEBI while granting registration to all 10 AIFs in this category have taken
undertakings/affidavits etc and has approved the application subject to these
leverage and risk management conditions only. So the only effect of the AIF
Circular, so far as it provides additional norms for category III AIF, is that
instead of asking for compliances of such conditions applications wise, SEBI
has now issued a complete code in form a circular to be adhered by all category
III AIFs.
exposed to risks and are allowed to borrow outside funds, stringent conditions
for risk mitigation and control should be in place and that is what SEBI has
done. By limiting the amount of leverage and putting certain rigorous
disclosure requirements on breach of leverage, SEBI has tried to provide a
regulatory control over category III AIFs. However, a notable point is that
SEBI while granting registration to all 10 AIFs in this category have taken
undertakings/affidavits etc and has approved the application subject to these
leverage and risk management conditions only. So the only effect of the AIF
Circular, so far as it provides additional norms for category III AIF, is that
instead of asking for compliances of such conditions applications wise, SEBI
has now issued a complete code in form a circular to be adhered by all category
III AIFs.
Implications when there is a
breach of leverage limits
– AIFs to send a
report to the custodian as soon as there is a breach of limits;
report to the custodian as soon as there is a breach of limits;
– AIFs to send a
report to all its clients before 10 a.m. on the next working day stating the
reason for breach;
report to all its clients before 10 a.m. on the next working day stating the
reason for breach;
– In addition to
actions which SEBI may take, AIFs to bring back the leverage within limit by
end of next working day. A confirmation in this regard is to be sent to all the
clients by the AIF by end of the day on which the exposure was squared off;
actions which SEBI may take, AIFs to bring back the leverage within limit by
end of next working day. A confirmation in this regard is to be sent to all the
clients by the AIF by end of the day on which the exposure was squared off;
– Custodian to
report to SEBI providing name of the fund, the extent of breach and reasons for
the same before 10 a.m. on the next working day; and
report to SEBI providing name of the fund, the extent of breach and reasons for
the same before 10 a.m. on the next working day; and
– Confirmation
of squaring off of the excess exposure shall be sent to SEBI by the custodian
by end of the day on which the exposure was squared off.
of squaring off of the excess exposure shall be sent to SEBI by the custodian
by end of the day on which the exposure was squared off.
Analysis
Strict disclosure and reporting
requirements for breach of leverage limits have been imposed. However, will it
be possible for an AIF to adhere to such strict reporting and compliance
requirements to be met within a day? Such requirement of SEBI is a ‘wait and
watch’ condition and non-compliances or difficulties in compliances can be
known only after practical experience by the AIFs. It is pertinent to note that
not only the AIF but also their custodian has been made liable for making
appropriate disclosure when there is a breach of leverage limits. Non-compliance
with these requirements would not only attract the penal provisions of AIF
Regulations but also the provisions of SEBI Act.
requirements for breach of leverage limits have been imposed. However, will it
be possible for an AIF to adhere to such strict reporting and compliance
requirements to be met within a day? Such requirement of SEBI is a ‘wait and
watch’ condition and non-compliances or difficulties in compliances can be
known only after practical experience by the AIFs. It is pertinent to note that
not only the AIF but also their custodian has been made liable for making
appropriate disclosure when there is a breach of leverage limits. Non-compliance
with these requirements would not only attract the penal provisions of AIF
Regulations but also the provisions of SEBI Act.
Redemption and suspension norms
for open ended schemes of category III AIF
The redemption norms as laid down
by the AIF Circular are applicable to existing as well as to all new schemes of
AIFs. The managers of such AIF have been entrusted with greater responsibility
of ensuring adequate and sufficient liquidity and management policies for
redemption of any open-ended scheme of the AIF. The redemption can be suspended
if so thought appropriate by the manager in the best interest of the investors
of the AIF or if so required under the AIF Regulations. The reasons of and
planned actions after the suspension are to be intimated to SEBI as well as to
the investors. Further, the manager of an AIF whose scheme is suspended is to
take all necessary steps in order to resume normal operations as soon as
possible having regard to the best interest of investors and such decision of
resuming operation of the scheme is to be intimated to SEBI and investors as
soon as possible.
by the AIF Circular are applicable to existing as well as to all new schemes of
AIFs. The managers of such AIF have been entrusted with greater responsibility
of ensuring adequate and sufficient liquidity and management policies for
redemption of any open-ended scheme of the AIF. The redemption can be suspended
if so thought appropriate by the manager in the best interest of the investors
of the AIF or if so required under the AIF Regulations. The reasons of and
planned actions after the suspension are to be intimated to SEBI as well as to
the investors. Further, the manager of an AIF whose scheme is suspended is to
take all necessary steps in order to resume normal operations as soon as
possible having regard to the best interest of investors and such decision of
resuming operation of the scheme is to be intimated to SEBI and investors as
soon as possible.
Reporting requirements for all
categories of AIFs
AIF Regulations were silent on
any reporting requirements and power was given to SEBI to issue guidelines in
this respect. Accordingly, category I, category II and category III AIFs (which
do not undertake leverage) are required to submit a quarterly return (as per
the specified format) and category III AIFs employing leverage are to submit
the return on monthly basis within 7 calendar days from the end of the
quarter/month (however, returns of the quarter ending on June 30, 2013 are to
be submitted within 30 days from the date of AIF Circular). Reporting is to be
done online however, till such online system is made available, reports are to be
sent by email to [email protected].
Further, as a green initiative, SEBI has advised AIFs not to file physical
reports.
any reporting requirements and power was given to SEBI to issue guidelines in
this respect. Accordingly, category I, category II and category III AIFs (which
do not undertake leverage) are required to submit a quarterly return (as per
the specified format) and category III AIFs employing leverage are to submit
the return on monthly basis within 7 calendar days from the end of the
quarter/month (however, returns of the quarter ending on June 30, 2013 are to
be submitted within 30 days from the date of AIF Circular). Reporting is to be
done online however, till such online system is made available, reports are to be
sent by email to [email protected].
Further, as a green initiative, SEBI has advised AIFs not to file physical
reports.
As per the given formats of
reporting, apart from the general information, category I, II and III AIFs (not
employing leverage) are required to give cumulative details of funds raised and
invested by all schemes under the AIF, details of investments made during the
relevant quarter, break up of investments made in associate companies, details
of categories of investors, industry sector wise investments details.
reporting, apart from the general information, category I, II and III AIFs (not
employing leverage) are required to give cumulative details of funds raised and
invested by all schemes under the AIF, details of investments made during the
relevant quarter, break up of investments made in associate companies, details
of categories of investors, industry sector wise investments details.
Apart from the details as
mentioned in the preceding para, category III AIFs employing leverage are
additionally required to disclose the details of scheme wise leverage undertaken
and details of leverage reported to custodian on daily basis in its monthly
return.
mentioned in the preceding para, category III AIFs employing leverage are
additionally required to disclose the details of scheme wise leverage undertaken
and details of leverage reported to custodian on daily basis in its monthly
return.
Conclusion
After several scams like the recent one in West Bengal by
Saradha Group who collected thousands of crores of money from investors
illegally in front of all regulators, there comes a law covering the loophole
of extant laws. However, there is a need for regulators to keep a watch on
money collectors from the very beginning and not when they default. Obviously,
so much money is neither raised overnight, nor silently, as there is a massive
machinery of agents who do it from the very bottom of the population pyramid.
Even though the Saradha Group was regularly submitting its balance sheet with
the Registrar of Companies, its huge money collection could only be traced when
several investors had already burnt their fingers. In other words, there are several
banning/preventing laws prevailing in India and requiring several disclosures
and compliances by such companies from time to time; however, the media is
replete with several investment scams and similar stories. Likewise, in the case
of category III AIFs which have been allowed to employ leverage and borrow from
public, the effectiveness of disclosure, operational and prudential
requirements of SEBI introduced by the AIF Circular remains to be seen in times
to come.
Saradha Group who collected thousands of crores of money from investors
illegally in front of all regulators, there comes a law covering the loophole
of extant laws. However, there is a need for regulators to keep a watch on
money collectors from the very beginning and not when they default. Obviously,
so much money is neither raised overnight, nor silently, as there is a massive
machinery of agents who do it from the very bottom of the population pyramid.
Even though the Saradha Group was regularly submitting its balance sheet with
the Registrar of Companies, its huge money collection could only be traced when
several investors had already burnt their fingers. In other words, there are several
banning/preventing laws prevailing in India and requiring several disclosures
and compliances by such companies from time to time; however, the media is
replete with several investment scams and similar stories. Likewise, in the case
of category III AIFs which have been allowed to employ leverage and borrow from
public, the effectiveness of disclosure, operational and prudential
requirements of SEBI introduced by the AIF Circular remains to be seen in times
to come.
– Nidhi Ladha
[1] As on
April 22, 2013
April 22, 2013
[2] Text of
the Circular is available at https://indiacorplaw.in/wp-content/uploads/2013/08/1375094611151.pdf
the Circular is available at https://indiacorplaw.in/wp-content/uploads/2013/08/1375094611151.pdf
