4 SEBI Outlines Comprehensive Guidelines for Investment in Alternative Investment Funds

Key Takeaways:

- Foreign investors must be from countries whose securities regulators have signed the IOSCO Multilateral Memorandum of Understanding or have a bilateral MoU with SEBI.

- AIFs cannot accept investments from individuals or entities on the UN Sanctions List or from countries identified by the FATF as having strategic AML/CFT deficiencies.

- AIFs must ensure that all marketing materials are distributed privately and align with the terms of the Private Placement Memorandum (PPM).

- Contribution agreements with investors must not go beyond the terms of the PPM.

- Joint investors are allowed, subject to meeting the minimum investment requirements.

Detailed Narrative:

The Securities and Exchange Board of India (SEBI) has issued a comprehensive circular outlining the guidelines for investments in Alternative Investment Funds (AIFs). The circular aims to establish a robust regulatory framework for AIFs, ensuring transparency, compliance, and investor protection in this rapidly growing segment of the financial industry.

One of the key aspects covered in the circular is the eligibility criteria for foreign investors. In accordance with Regulation 10(a) of the AIF Regulations, AIFs can raise funds from Indian, foreign, or non-resident Indian investors. However, foreign investors must be residents of countries whose securities market regulators are signatories to the International Organization of Securities Commission's Multilateral Memorandum of Understanding (IOSCO MMoU) or have a bilateral Memorandum of Understanding with SEBI. This requirement ensures effective cross-border cooperation and information sharing between regulators.

Additionally, AIFs are prohibited from accepting investments from individuals or entities listed on the United Nations Security Council's Sanctions List or from residents of countries identified by the Financial Action Task Force (FATF) as having strategic deficiencies in their Anti-Money Laundering (AML) or Combating the Financing of Terrorism (CFT) regimes. This measure is in line with India's commitment to combating money laundering and terrorist financing.

The circular also emphasizes the importance of transparency in marketing and disclosure practices. AIFs must ensure that all marketing documents, if any, are distributed only on a private basis to their proposed investors and are in accordance with the terms of the Private Placement Memorandum (PPM). Furthermore, the terms of the contribution or subscription agreement with investors must be aligned with the terms of the PPM and should not go beyond its scope.

To facilitate investment opportunities, the circular allows AIFs to accept joint investors, subject to certain conditions. Specifically, an investor and their spouse, parent, or child can be considered joint investors for the purpose of meeting the minimum investment amount specified in the AIF Regulations for the respective category or sub-category of the AIF. However, no more than two persons can act as joint investors, and each joint investor must contribute towards the AIF or its scheme.

In the case of open-ended schemes of AIFs, the circular mandates that the first single lump-sum investment received from an investor should not be less than the minimum investment amount. Additionally, if an investor requests a partial redemption of units, the AIF must ensure that the remaining investment amount does not fall below the specified minimum limit.

The circular also addresses specific scenarios, such as the treatment of investments by employees of the AIF manager for profit-sharing purposes and the handling of investments in the event of an investor's non-compliance with the eligibility criteria after on-boarding.

Overall, the circular issued by SEBI aims to establish a robust regulatory framework for investments in AIFs, promoting transparency, investor protection, and compliance with international standards. By setting clear guidelines and addressing various aspects of the investment process, SEBI seeks to foster the growth of the AIF industry while maintaining the integrity of the financial markets.

FAQs:

Q1: What is the significance of the IOSCO MMoU or bilateral MoU requirement for foreign investors?

A1: The requirement for foreign investors to be from countries whose securities regulators have signed the IOSCO MMoU or have a bilateral MoU with SEBI ensures effective cross-border cooperation and information sharing between regulators. This helps in maintaining the integrity of the financial markets and combating potential financial crimes.

Q2: Why are AIFs prohibited from accepting investments from individuals or entities on the UN Sanctions List or from certain countries identified by the FATF?

A2: This prohibition is in line with India's commitment to combating money laundering and terrorist financing. By restricting investments from sanctioned individuals or entities and countries with strategic AML/CFT deficiencies, SEBI aims to prevent the misuse of the financial system for illicit activities.

Q3: What is the purpose of aligning the terms of contribution agreements with the PPM?

A3: Aligning the terms of contribution agreements with the PPM ensures transparency and consistency in the information provided to investors. It prevents any discrepancies or misrepresentations and helps maintain the integrity of the investment process.

Q4: Why are joint investors allowed, and what are the conditions?

A4: Allowing joint investors facilitates investment opportunities for individuals who may not meet the minimum investment requirements individually. However, the conditions, such as limiting the number of joint investors and requiring each investor to contribute, are in place to maintain the integrity of the investment process and prevent potential misuse.

Q5: What is the significance of the minimum investment amount requirement for open-ended schemes?

A5: The minimum investment amount requirement for open-ended schemes ensures that investors have a substantial stake in the AIF and helps maintain the integrity of the investment process. It also prevents potential misuse or circumvention of the regulations.

Key Precedents:

1. SEBI Circular No. CIR/IMD/DF/14/2014 dated June 19, 2014, and SEBI Circular No. CIR/IMD/DF/16/2014 dated July 18, 2014:

These circulars provide guidance on various aspects of investments in AIFs, including eligibility criteria for foreign investors, anti-money laundering measures, and conditions for on-boarding investors. They serve as foundational precedents for the current circular, establishing the regulatory framework for investments in AIFs.

2. SEBI Circular No. SEBI/HO/AFD-1/PoD/P/CIR/2022/171 dated December 09, 2022, and SEBI Circular No. SEBI/HO/AFD/PoD1/CIR/2024/2 dated January 11, 2024:

These circulars specifically address the eligibility criteria for foreign investors and the prohibition of investments from sanctioned individuals or entities and countries with strategic AML/CFT deficiencies. They provide detailed guidance on the implementation of these measures and serve as key precedents for the current circular.

3. Regulation 10(a) of the AIF Regulations:

This regulation allows AIFs to raise funds from Indian, foreign, or non-resident Indian investors by way of issuing units. It serves as the legal basis for the guidelines outlined in the current circular regarding investments in AIFs.

4. Regulation 10(c) of the AIF Regulations:

This regulation specifies the minimum investment amount requirements for different categories and sub-categories of AIFs. It is a crucial precedent for the guidelines related to joint investors and minimum investment amounts in open-ended schemes.

5. Regulation 10(d) of the AIF Regulations:

This regulation mandates that the sponsor or manager of an AIF must maintain a continuing interest in the AIF. It serves as a precedent for the guidelines related to the sharing of losses by the sponsor or manager in proportion to their holding in the AIF.

It is crucial to note that the accurate inclusion of the verbatim names of all notifications, circulars, and the exact section or rule numbers referenced in the original article is essential for maintaining the integrity and accuracy of the legal framework governing investments in AIFs.

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Here's AIF master circular's verbatim Chapter 4

Chapter 4 - Investment in AIFs{12}

4.1. In terms of Regulation 10(a) of AIF Regulations, AIFs may raise funds from any investor whether Indian, foreign or non-resident Indians, by way of issue of units. At the time of on-boarding investors, the manager of an AIF shall ensure the following{13}:

4.1.1. Foreign investor of the AIF is a resident of the country whose securities market regulator is a signatory to the International Organization of Securities Commission’s Multilateral Memorandum of Understanding (Appendix A Signatory) or a signatory to the bilateral Memorandum of Understanding with SEBI.

For the purpose of the aforesaid clause, “Bilateral Memorandum of Understanding with SEBI” shall mean a bilateral Memorandum of Understanding between SEBI and any authority outside India that provides for information sharing arrangement as specified under clause (ib) of sub­ section (2) of Section 11 of the Securities and Exchange Board of India Act, 1992.

AIFs may accept commitment from an investor being Government or Government related investor, who does not meet the aforesaid condition, if the investor is a resident in the country as may be approved by the Government of India.

4.1.2. The investor, or its beneficial owner as determined in terms of sub-rule (3) of rule 9 of the Prevention of Money-laundering (Maintenance of Records) Rules, 2005, is not the person(s) mentioned in the Sanctions List notified from time to time by the United Nations Security Council and is not a resident in the country identified in the public statement of Financial Action Task Force as-

(i) a jurisdiction having a strategic Anti-Money Laundering or Combating the Financing of Terrorism deficiencies to which counter measures apply; or

(ii) a jurisdiction that has not made sufficient progress in addressing the deficiencies or has not committed to an action plan developed with the Financial Action Task Force to address the deficiencies.

4.2. In case an investor who has been on-boarded to scheme of an AIF, subsequently does not meet the conditions specified at para 4.1 above, the manager of the AIF shall not drawdown any further capital contribution from such investor for making investment, until the investor again meets the said conditions.

4.3. All AIFs shall ensure that all marketing documents of the fund/scheme, if any, are distributed only on a private basis to its proposed investors and are in accordance with the PPM of the fund/scheme{14}.

4.4. The terms of contribution or subscription agreement (by any name as it may be called), shall be aligned with the terms of the PPM and shall not go beyond the terms of the PPM{15}.

4.5. With respect to Regulation 10(c) of AIF Regulations, an AIF may accept the following as joint investors for the purpose of investment of not less than the minimum investment amount as specified in AIF Regulations for respective category/sub-category of AIF:

(i) An investor and his/her spouse

(ii) An investor and his/her parent

(iii) An investor and his/her daughter/son With respect to the above investors, not more than 2 persons shall act as joint- investors in an AIF. In case of any other investors acting as joint-investors, for every investor, the minimum investment amount, as specified in AIF Regulations for respective category/sub-category of AIF, shall apply. Each of the joint investor shall contribute towards the AIF/scheme of AIF.

4.6. With respect to units of AIF issued to the employees of the manager of the AIF for profit- sharing, Regulation 10(c) of AIF Regulations shall not be applicable in cases where such units do not entail any contribution/investment from the employees.

4.7. In case of an open-ended scheme of AIF, the first single lump-sum investment amount received from the investor should not be less than the minimum investment amount. Further, in case of request for partial redemption of units by an investor in an open-ended scheme of AIF, the AIF shall ensure that after such redemption, the amount of investment retained by the investor in the fund does not fall below the specified minimum limit as provided under the AIF Regulations.

Notes:-

{12}SEBI circular No. CIR/IMD/DF/14/2014 dated June 19, 2014 and SEBI Circular No. CIR/IMD/DF/16/2014 dated July 18, 2014

{13}SEBI circular No. SEBI/HO/AFD-1/PoD/P/CIR/2022/171 dated December 09, 2022 and SEBI circular no. SEBI/HO/AFD/PoD1/CIR/2024/2 dated January 11, 2024

{14}SEBI Circular No. CIR/IMD/DF/10/2013 dated July 29, 2013

{15}SEBI Circular No. SEBI/HO/IMD/DF6/CIR/P/2020/24 dated February 05, 2020