On January 6, 2023, the Securities and Exchange Board of India (“SEBI”) released a consultation paper on a standardised approach to the valuation of investment portfolios of alternative investment funds (the “Consultation Paper”) in respect of which comments may be sent till January 23, 2023.

Existing law

AIF Regulations focus on disclosures to investors regarding the valuation of investments and presently do not prescribe any guidelines. Therefore, managers of AIFs have the flexibility to adopt any principle/methodology/standard for valuation of investment portfolio of the AIFs managed by them. The modalities relating to valuation of investment portfolio of the AIFs are not disclosed in the PPMs either at the time of submission to SEBI and also not reported to SEBI subsequently.

The current regulatory framework on valuation of investment portfolio of AIFs prescribed under the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”) is as follows:

1. Regulation 23(1): The AIF shall provide to its investors, a description of its valuation procedure and of the methodology for valuing assets.
2. Regulation 23(2) - Category I and Category II AIFs shall undertake valuation of their investments, at least once in every 6 months, by an independent valuer, provided that such period may be enhanced to one year on approval of at least 75% of the investors by value of their investment in the AIF.
3. Regulation 23(3) - Category III AIFs shall ensure that calculation of the net asset value (NAV) is independent from the fund management function of the AIF and such NAV shall be disclosed to the investors at intervals not longer than a quarter for close ended Funds and at intervals not longer than a month for open ended funds.
4. Regulation 27(1)(b) - The manager or sponsor is required to maintain records describing valuation policies and practices.

As per the template PPM prescribed by SEBI on February 5, 2020, Category I & II AIFs are required to disclose details of the entity to be appointed as the valuer of the fund/scheme, frequency of valuation of the portfolio companies, valuation principles used by the fund/scheme for valuation of portfolio companies (whether the fund/scheme follows the IPEV Guidelines) or any other guiding principles relevant for the investors to know with respect to valuation of the fund/scheme.

Issues addressed in the Consultation Paper and proposals by SEBI

1. Need for standardised approach to valuation methodology

A standardised approach with regard to valuation principles for valuing investment portfolio shall ensure the following:

• fair disclosure of value of investment portfolio to the investors;
• uniformity across the AIF industry and performance of a particular AIF;

SEBI has proposed in the Consultation Paper that (i) AIFs must be required to carry out valuation of their investment portfolio as per International Private Equity and Venture Capital Valuation Guidelines, and (ii) the valuation norms prescribed for certain securities/instruments for Mutual Funds under SEBI (Mutual Funds) Regulations, 1996 shall also be specified for the valuation of investment portfolios of AIFs.

2. Criteria for Independent Valuer

While Category I & II AIFs are required to undertake valuation of their investments through an independent valuer, no criteria have been prescribed in AIF Regulations for such independent valuer. The need for an independent valuer arises because Category I and II AIFs invest predominantly in unlisted securities where the market price is unavailable. Currently, Category III AIFs are not required to appoint an independent valuer to assess their investment portfolio. However, given that Category III AIFs may invest in unlisted securities under the current regulatory framework, it is deemed suitable that independent valuers may conduct the valuation of such unlisted securities for the purposes of calculating NAV.

SEBI has proposed the following criteria while appointing an independent valuer:

• Valuer is registered with Insolvency and Bankruptcy Board of India (IBBI);
• Valuer has membership of a professional institute established by an Act of Parliament enacted for the purpose of regulation of a profession such as Institute of Chartered Accountants of India, Institute of Company Secretaries of India, Institute of Cost Accountants of India, etc. or a CFA charter from the CFA institute;
• Valuer has at least 3 years’ experience in valuation of unlisted securities; and
• Valuer is not an associate of the manager / sponsor / trustee of the AIF.

3. Reporting of valuation to performance benchmarking agencies

Presently, the timelines for reporting data on cash flows and valuation of scheme wise investments of AIFs to performance benchmarking agencies is:

• by September 30, every year for audited data as on March 31,
• by November 15 every year for unaudited data as on September 30.

Consequently, performance benchmarking reports of AIFs by performance benchmarking agencies for audited data as on March 31 is published around November-December and performance benchmarking reports of AIFs for unaudited data as on September 30 is published by around January-February. Thus, the performance benchmarking report based on the March data gets outdated within 2 months. Additionally, in terms of the Companies Act 2013, unlisted private limited companies are required to submit an audit report within 6 months from end of financial year, i.e. by September 30, which coincides with the timeline for submitting the valuation based on audited data of investee companies to performance benchmarking agencies.

Hence, SEBI has proposed that managers of AIFs shall be required to ensure that one of the terms in subscription agreement/investment agreement with the investee company, stipulates a specific timeframe for providing its audited accounts to the AIF. This would enable managers of AIFs to report the valuation based on audited data as on March 31, to performance benchmarking agencies within the specified timeline of 6 months.

4. Responsibilities of managers of AIFs with regard to valuation of their investment portfolio and related disclosures

Presently, AIF Regulations do not cast any responsibility on managers of AIFs with regard to fair valuation of investment portfolio of AIFs managed by them. However, such a responsibility has been cast on asset management companies of mutual funds under Regulation 25(19) of SEBI (Mutual Funds) Regulations, 1996.

SEBI has proposed that:

• Managers of all SEBI registered AIFs shall be required to ensure that the independent valuer computes and carries out valuation of investments made by the scheme(s) of AIFs in accordance with the stipulated guidelines.
• The Manager shall be required to be responsible for a true and fair valuation of the investments made by the relevant scheme of the AIF, provided that where the established policies and procedures of valuation do not result in fair and appropriate valuation, the manager may be required to deviate from the established policies and procedures in order to value the assets or securities at a fair value and document the rationale for such deviations.
• Any such deviation from the disclosed valuation policy and procedures shall be allowed along with disclosure of the documented rationale to the trustee or the trustee company or the Board of Directors or designated partners of the AIF and investors of the AIF.
• At each asset level, in case there is a deviation of more than 20% between two consecutive valuations or a deviation of more than 33% in a financial year, the manager shall be required to inform the investors the reasons/factors for the same, both generic and specific, including but not limited to change in accounting practices/policy and/or changes in assumptions/projections or changes in valuation principle, and reasons thereof.

Please find a copy of the Consultation Paper, here.

This update has been contributed by Vinod Joseph (Partner) and Anushkaa Shekhar (Associate)

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