Proposal to Prevent Circumvention of Financial Sector Regulations by AIFs

Key Takeaways:

1. Background and Issues Identified

The AIF industry has shown consistent growth, but instances of circumvention of financial sector regulations have emerged.

Identified modus operandi include ever-greening of loans by regulated lenders, circumvention of FEMA norms, and circumvention of QIB regulations.

Most identified cases of circumvention had a single investor or investors of the same group, impacting the trust and integrity of the AIF ecosystem.

2. Global Developments

Heightened global regulatory concerns around the private equity industry have been observed.

Various regulatory bodies, such as IOSCO-CER, SEC, and the UK’s Financial Conduct Authority, are addressing risks related to private assets.

3. Proposed Regulatory Approach

The proposal aims to address regulatory concerns in a proportionate, risk-based manner while facilitating ease of doing business and compliance.

SEBI is piloting deeper engagement with industry participants through the formation of various Industry Standards Fora across segments of the securities market.

4. Consultation with Stakeholders

The Alternative Investment Policy Advisory Committee (AIPAC) of SEBI recommended the introduction of a general obligation and specific implementation standards to be formulated by the Standards Forum for AIFs (SFA), in consultation with SEBI.

5. Proposal Details

The proposal suggests inserting a provision in the SEBI (AIF) Regulations, 2012, requiring specific due diligence with respect to investors and investments to prevent circumvention of extant regulations.

SEBI will prescribe a framework to specify the objectives and regulatory principles to address regulatory circumventions.

Synopsis:

The provided is a consultation paper that proposes measures to address the circumvention of financial sector regulations by Alternative Investment Funds (AIFs) in India. The paper highlights the robust growth of the AIF industry and the need to restore trust in the system by preventing instances of circumvention while ensuring minimal impact on legitimate AIF investments. It also discusses specific instances of circumvention, global regulatory concerns, and the proposed regulatory approach.

The key points and proposals outlined in the consultation paper:

Background and Issues Identified

1. Growth of AIF Industry: The AIF industry has shown consistent growth, with investments rising to INR 3,53,352 Crore as of September 30, 2023. AIFs connect sophisticated investors with enterprises in need of risk capital, complementing other sources of funding such as banks, financial institutions, and listed markets.

2. Regulatory Concerns: Compared to other SEBI registered investment channels, AIFs have a relatively light-touch regulatory regime. However, instances of AIFs being structured to circumvent financial sector regulations have emerged, leading to erosion of trust in the system. SEBI has identified over 40 cases involving over INR 30,000 crores where AIFs appear to have been structured to facilitate circumvention of certain financial sector regulations.

Identified Modus Operandi

The paper outlines specific instances where AIFs are being structured to facilitate circumvention of financial sector regulatory frameworks, including:

Ever-greening of loans by regulated lenders: AIFs have been set up resulting in ever-greening of stressed loans of regulated lenders, circumventing RBI regulations and disclosure requirements.

Circumvention of FEMA norms: Some AIFs appear to have been set up specifically with the intent to circumvent the provisions relating to regulatory framework for foreign investment.

Circumvention of QIB regulations: Certain AIFs, which have single or very few investors, have invested in IPOs under QIB quota, availing benefits available to QIBs under SEBI regulations.

Global Developments

The paper highlights heightened global regulatory concerns around the private equity industry, citing the IOSCO-CER report and new rules adopted by the US Securities and Exchange Commission (SEC) for regulation of Private Fund Advisors.

Proposed Regulatory Approach

The proposed approach aims to address regulatory concerns in a proportionate, risk-based manner while facilitating ease of doing business and compliance. It emphasizes the need to prevent undesirable events/misuse while ensuring that regulations do not hinder legitimate investments.

Specific Proposals

1. General Obligation: The paper proposes to introduce a general obligation in the existing AIF regulations that would require AIFs, managers, and their key management personnel to ensure that their operations and investments do not facilitate circumvention of regulations administered by any financial sector regulator.

2. Industry Standards Forum for AIFs (SFA): The pilot SFA, in consultation with SEBI, is proposed to formulate specific verifiable standards to demonstrate adherence to the general obligation.

Consultation and Public Comments

The paper seeks comments and inputs from all stakeholders and the public on the proposed measures. It provides details on how stakeholders can submit their comments through online web-based forms or by email.

In summary, the consultation paper addresses the need to restore trust in the AIF ecosystem by proposing measures to prevent circumvention of financial sector regulations while ensuring minimal impact on legitimate AIF investments. It emphasizes the importance of industry standards and public input in formulating and implementing these measures.

FAQ

Q1: What is the purpose of the consultation paper?

A1: The consultation paper aims to address instances of AIFs being structured to circumvent financial sector regulations, restore trust, and prevent such circumvention while ensuring minimal impact on legitimate AIF investments.

Q2: How will the proposed regulatory approach balance concerns and legitimate investments?

A2: The proposed approach aims to address regulatory concerns in a proportionate, risk-based manner while facilitating ease of doing business and compliance, ensuring that regulations do not hinder legitimate investments.

Q3: What are the key global developments in the private equity industry?

A3: Heightened global regulatory concerns around the private equity industry have been observed, with various regulatory bodies addressing risks related to private assets.

Q4: How can stakeholders provide comments on the proposal?

A4: Stakeholders can provide comments through the online web-based form provided by SEBI or by forwarding comments via email to afdconsultation@sebi.gov.in, following the instructions provided.