The choice of business form available in any jurisdiction is critical to the establishment of a vibrant fund industry. While several markets have historically relied on organisational structures such as the limited partnership, the age-old private trust formulation has constituted the mainstay of the fund industry in India. Most fund structures (including mutual funds and alternative investment funds) are established as trusts and governed by the Indian Trusts Act, 1882. In a paper, a colleague and I seek to identify the rationale for this approach, including by interviewing some lawyers advising clients in matters of fund formation. Factors of path dependency have cemented the use of trusts and prevented the emergence newer business forms in India.
However, the regime surrounding international financial services centres (IFSCs) through the International Financial Services Centres Authority Act, 2019 (IFSCA Act) has led to a change in approach. There has been a recognition that the status quo in terms of business forms cannot continue if the IFSCs were to attract international financial services firm to establish businesses therein. It would be necessary to create business forms that are more universal and modern. The first step in this regard was taken with the constitution of the K.P. Krishnan Committee in September 2020, which issued its report in May 2021. That committee recommended the broad framework for the establishment of variable capital companies (VCCs) in the IFSCs.
As a sequel, more recently another committee under the chairmanship of Professor M.S. Sahoo has issued the “Report of the Expert Committee for drafting a Legal Framework for allowing Variable Capital Company Structure in the IFSCs”, which was made publicly available on 30 November 2022. The Sahoo committee report creates a specific legal framework for VCCs within IFSCs, and also suggests amendments to the IFSCA Act to accomplish the same. VCCs are not novel, as they have been in existences for a few years, in particular in various global financial centres. Some jurisdictions such as Singapore have incorporated the model into their legislation more recently, for example through the Singapore Variable Capital Companies Act 2018.
Among others, VCCs bear two characteristics that are beneficial for the organisation of pools of capital. The first is that their securities are redeemable, which enables them to return capital to shareholders, for instance whenever they liquidate their own investments in investee companies. In that sense, they can be either open-ended or close-ended. The second, and more importantly, VCCs may consist either of a single pool of capital, or multiple pools of capital. When there are multiple pools, each pool (also referred to as a “sub-fund”) could carry its own assets and liabilities, which are distinct from the assets and liabilities of other sub-funds. Hence, an investor in a sub-fund can participate specifically in the assets and liabilities (and profits and losses) of that sub-fund, without have any interest whatsoever in the other sub-funds owned and managed by a VCC. In that sense, the VCC structure enables ring-fencing of sub-funds although all of them operate under the same VCC entity. The VCC entity itself has the general features akin to that of a company, such as perpetual succession and the ability to own property, among others.
The Sahoo Committee Report reveals the deliberations regarding the most optimal legal route to be adopted to formalise the VCC structure. One option would have been to amend the Companies Act, 2013 to recognise VCCs. But, that would have meant making the structure available not only to foreign funds operating in the IFSCs but also to domestic funds as well. This was found to be premature, and rightly so. Given that it is the foreign funds (who are more familiar with modern business forms such as VCCs) that need the benefit of the regime, the Committee felt that the more appropriate method would be to introduce it through amendments to the IFSCA Act. In that sense, the VCCs would be available, at least initially, only to funds operating in the IFSCs. The idea undergirding this approach suggests that VCCs can effectively be experimented in the IFSCs first before the rest of the corporate sector domestically is exposed to that business form.
The Sahoo Committee Report contains further details regarding the nature of VCCs and some of the specific aspects such as capital structure, auditing, insolvency, and the like. Specific reforms have also been suggested on matters of taxation. The report also contains a useful comparison of the VCC structure in India with that in other jurisdictions such as Singapore, the United Kingdom, Mauritius, Ireland, and Luxembourg.
Overall, these developments are welcome, as they would effectively modernize the fund structures in the IFSCs. This would be a sea change from India’s reliance on the more generic trust structure. At the same time, by limiting the applicability of VCCs to the IFSCs, any risks arising from the structure can also be contained to a smaller portion of the economy.