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.
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:
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
A standardised approach with regard to valuation principles for valuing investment portfolio shall ensure the following:
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.
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:
Presently, the timelines for reporting data on cash flows and valuation of scheme wise investments of AIFs to performance benchmarking agencies is:
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.
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:
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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