SEBI Pushes for Enhanced Reporting in AIFs

While the rules governing Alternative Investment Funds (AIFs) have traditionally been light touch in nature due to the involvement of sophisticated investors, SEBI has recognized the need for stronger oversight to safeguard investor interests and maintain the integrity of capital markets. Through various regulatory measures and consultations, SEBI has demonstrated its commitment to enhancing reporting standards in PE and VC investments.

One of the key areas of focus for SEBI has been valuation practices in AIFs. Many AIFs, particularly close-ended funds, have substantial exposure to unlisted stocks. While open-ended funds are required to publish the Net Asset Value (NAV) on a monthly basis, close-ended funds often announce the NAV semi-annually or even annually.

SEBI has recognized the importance of credible valuation exercises and has mandated AIFs to disclose their valuation practices, including details about the qualification of the valuer, any significant changes in valuation methodology, whether it is based on audited statements, and any associations between the valuer and the fund or its manager. By doing so, SEBI aims to add credibility to NAV calculation.

This should also help in comparing the performance of funds. In fact, the performance benchmarking reports are now published and can be accessed by investors as well. Investors can use the performance benchmarking reports to compare alternative investment funds prior to taking an investment decision and also for the purpose of performance monitoring post investments. This is a big stride in making private equity and venture capital investments transparent for investors.

Another area of concern for SEBI has been the extension of fund tenures. Some funds, launched in 2012-13 had been extending their lifecycles, citing the risk of a fire sale of assets and securities, without sufficient investor consent. This was leading to a delay in the distribution of capital to investors. To address this issue, SEBI has made it clear that funds must close and liquidate within the specified period, even if a majority of investors give consent to extend the tenure. This measure will prevent fund managers from indefinitely stretching the lives of funds and ensures timely liquidation.

The regulator has also made the dematerialization of AIF units a mandatory requirement for funds. AIFs with a corpus of more than INR 500 crores are required to dematerialize their units by October 31, 2023, while other AIFs with a corpus equal to or less than INR 500 crores have until April 30, 2024, to comply. This move aims to enhance monitoring and administration by stakeholders and reduce operational and fraud risks, thus providing greater protection to investors.

To mitigate conflicts of interest, SEBI has mandated that AIFs cannot engage in investment transactions with associates or other AIFs managed or sponsored by the same entities, without the approval of at least 75% of investors by value. Additionally, transactions with investors who have committed to more than 50% of the scheme's corpus are also subject to the same approval requirement. By imposing these restrictions, SEBI ensures that AIFs maintain a high level of integrity and prevent potential conflicts that could compromise the investors’ interests.

SEBI's focus on segregation and ring-fencing of assets and liabilities within each scheme of an AIF further strengthens investor protection. This measure prevents the spillover of stress and liabilities from one scheme to another, safeguarding the interests of investors and minimizing systemic risks.

It has taken proactive steps by requesting funds to provide clarity on its resolution framework within the private placement memorandum (PPM). Furthermore, SEBI has asked funds to disclose the number of complaints received in the previous two financial years, as well as the number of complaints submitted to the resolution mechanism. These measures aim to ensure that funds have robust mechanisms in place to address investor concerns.

SEBI has also sought details on the overseas shareholders and ultimate beneficiaries of proposed investment managers and sponsors even beyond the general anti-money laundering regulations. This has been done to check if there is any beneficial ownership from specific geographies and to check on potential round-tripping concerns.

SEBI, however, recognizes the importance of striking a balance between regulatory measures and fostering a conducive environment for the growth of the industry. Last month, it told several fund managers that it would do a comprehensive review of the regulations to simplify, ease and reduce the cost of compliance for AIFs. It has asked them to suggest ways to lessen the compliance burden on the funds.

It has also made notable changes to the eligibility criteria for the key investment team and compliance officers. Instead of focusing on experience criteria, SEBI now requires a certification, allowing competent individuals without the required experience to enter the industry. This change fosters greater inclusivity and encourages talent to enter the PE and VC sectors, leading to a more diverse and dynamic investment landscape.

While the regulator has come up with several proposals to protect investors' interests, it has actively engaged industry participants in the process, ensuring a collaborative approach toward enhancing transparency and accountability. As the AIF sector continues to evolve, it is essential for SEBI to maintain a balance between regulatory oversight and facilitating innovation and growth, fostering an environment conducive to sustainable investment practices.