The Securities and Exchange Board of India (“SEBI”) has, through a Circular dated February 5, 2020 (“Circular”), issued disclosure standards for the growing Alternative Investment Funds (“AIFs”) space. The Circular was preceded by a Consultation Paper dated December 4, 2019. SEBI has introduced performance benchmarking as well as standardization of private placement memoranda (“PPMs”) to create a conducive environment for a sound AIF asset class in India.
Performance Benchmarking of AIFs
With the objective of enabling prospective and existing investors to compare individual AIFs’ performances with the performance of the AIF industry and against other investment avenues, as also global investment opportunities, the Circular introduces mandatory benchmarking of the performance of AIFs (including venture capital funds (“VCs”)) and a framework for facilitating the use of data collected by benchmarking agencies (“Agencies”) to provide customized performance reports. However, these requirements do not apply to Angel Funds registered under sub-category of VC Fund under Category I – AIF.
Any association of SEBI registered AIFs (“Association”), representing at least 51% of the number of AIFs, may notify one or more Agencies with whom each AIF will enter into an agreement for carrying out the benchmarking process. Where any past performance of the AIF is mentioned in the PPM or in any marketing or promotional document, the performance versus benchmark report for such AIF or scheme shall also be provided.
The Circular enumerates the following operational guidelines for implementation of performance benchmarking:
- The performance benchmarking will be carried out on a half yearly basis and the necessary information shall be provided by AIFs or schemes that have completed at least one year from the first closing.
- AIFs will provide data on cash flows and valuation of their scheme-wise investments to the Agencies including the details of valuation principles and the name of the valuation agency in the form and format required by each Agency as prescribed. The PPM is required to provide the manner of valuation of investments and the Agencies shall be informed regarding any changes.
- The data provided for March 31 each year shall be audited data and for September 30 may be unaudited data.
- For the purpose of reporting and benchmarking, “assets-under-management” will be the value of total capital drawn down under the scheme and shall be carried out on pre-tax net asset value of the scheme.
- Each Agency shall clearly provide the basis of benchmarking of individual AIFs or schemes as well as calculation of the industry benchmark, along with the benchmark report.
Standardised Template for PPM
In terms of regulation 11 of the SEBI (Alternative Investment Funds) Regulations, 2012, AIFs are required to issue a PPM to prospective investors to raise funds.
a. Minimum Disclosure Requirements
With the objective of ensuring a minimum standard of disclosure, SEBI has provided a template for PPMs filed by AIFs. The Circular provides two separate templates, one each for Category I and Category II AIFs and Category III AIFs respectively. The templates contain the minimum level of information in a simple format, and will come into effect from March 1, 2020.
b. Annual Audit of Compliances
Further, the AIFs are mandatorily required to carry out an annual audit of this compliance by an internal or external auditor or legal professional. The report of the audit has to be communicated to the trustee or board or designated partners of the AIF, board of the manager and SEBI.
c. Primacy of the PPM
The Circular expressly provides for the primacy of the PPM over other agreements such as the contribution agreements executed with the investors.
d. Exclusion of Angel Funds
The Consultation Paper did not provide for any exclusion from the disclosure compliances. However, after receiving comments from public, SEBI has excluded angel funds, a sub-category of Category I AIFs, from the requirement of adopting the prescribed template and carrying out the annual audit of the compliance.
e. Waiving Compliance with the Circular
In addition to the above, SEBI has also provided a format for waiver in the Circular, wherein AIFs or schemes in which each investor commits to a minimum capital contribution of INR 70 crores (USD 10 million or equivalent) can be excluded from the application of the Circular by providing a waiver taken from prospective investors in the prescribed format.
The number of AIFs has increased at a rapid pace and the performance benchmarking for AIFs is a step in the right direction since it will provide valuable data to investors while deciding to invest in a particular AIF. It may also give a boost to AIFs as an investment class since new investors may be attracted after being able to see the performance of different AIFs. However, the performance-benchmarking requirement is likely to increase the compliance costs for AIFs.
The directive that the PPM will have supremacy over side letters coupled with the requirement of disclosing the criteria for offering differential rights through side letters to any investor will ensure that the same class of investors are given the same rights. The introduction of a template is also likely to reduce the processing time for registration of AIFs. Additionally, SEBI’s decision to create a carve-out for angel funds seems to have been carried out on the basis of public feedback since such a carve-out was not envisaged in the Consultation Paper. The carve out for angel funds was necessary since the structure of angel fund is different from other AIFs. In an angel fund, each investor has to confirm their investment in a particular investee company through an undertaking. Overall, the steps taken by SEBI will bring transparency and depth to the AIF industry.
– Vaneesa Agrawal & Rishi Ahuja