S. No.

Subject matter

Existing provisions of AIF Regulations

Present Status/Issue faced by investors

SEBI proposal

Dematerialisation of units of AIFs

Units issued by AIFs are ‘securities’ as defined under the Securities Contracts (Regulation) Act, 1956. The Central Depository Services (India) Limited (CDSL) and National Securities Depository Limited (NSDL) have laid down procedures for dematerialisation of units of AIFs.

It is observed that units of most of the AIFs are not dematerialised and are held in physical form, since AIFs prefer to issue units in physical form.

Holding of units of AIFs in a dematerialised form would bring numerous benefits to all stakeholders such as ease of monitoring for investors and ease of transfer and transmission of AIF units.

a. Dematerialisation of units of AIFs shall be mandatory.

b. As part of the first phase of this mandate, by April 1,  2024, all schemes of AIFs with corpus of more than INR 500 crores, shall compulsorily dematerialise their units.

c. The terms of transfer of units of AIFs held by an investor shall continue to be governed by the terms of the private placement memorandum  (PPM),  agreements  between the investor and the AIF and other fund documents.

Direct plan to be offered by AIF

AIFs may currently offer a ‘direct plan’ for investors in their Private Placement Memorandum (PPM) at their option. Such a direct plan would not entail any distribution or placement fees for the investor.

Further, AIF Regulations do not place any restrictions on how much of any distribution commission or placement fee can be paid on an upfront basis to intermediaries.

Investors investing in an AIF through an Investment Adviser or Portfolio Manager are prone to be charged twice, once in the form of Investment Adviser’s advisory fee or Portfolio Manager’s portfolio management fee, and separately via the AIF distribution fee.

a. AIFs to be mandated to offer the option of a direct plan for investors, entailing no distribution/ placement fee.

b. AIFs shall have to ensure that any investor approaching an AIF through an intermediary, that is separately charging the investor a fee (such as advisory or portfolio management fee), invests in the AIF via the direct plan route only.

c. Investors on-boarded via the direct plan has to be provided an adjusted higher number of units, taking into account the lower distribution charges applicable to them versus other investors, such that all investors would continue to see the same Net Asset value (NAV) on their unit holdings.

Trail model of distribution commission in AIF

To reduce mis-selling, SEBI (Mutual Funds) Regulations,1996 and SEBI (Portfolio Managers) Regulations, 2020 mandate that Asset Management Companies and Portfolio Managers should adopt a full trail model of commission to their distributors. However, there are no regulatory guidelines in place with respect to commission/distribution fees in case of AIFs.

Industry feedback suggests that at least in some cases, the quantum of upfront commissions for AIF distribution has    gone up to around 4%-5% of the committed amount. Such high upfront commissions, particularly in sharp contrast to the trail commissions for other products, increases the chances of mis-selling of AIF schemes.

In case of Category III AIFs, investors may be charged placement fee/ distribution fee on a trail basis. In case of Category I AIFs and Category II AIFs, investors may also be charged on a trail basis. However, a certain higher amount of placement/ distribution fee (viz one-third of the present value of the total distribution fee) may be paid upfront in the first year

Treatment of unliquidated investments upon completion of a scheme’s tenure

Presently, AIFs/Managers have the following options upon expiry of the tenure of a scheme of AIF:

a. AIFs can extend the tenure of a scheme up to two years, subject to approval of two-thirds of the investors by value of their investment in the AIF.

b. AIFs/Managers have the option to distribute the assets of the AIF in-specie, after obtaining approval of at least 75% of the investors by value of their investment in the AIF.

c. In case neither of the aforementioned investors’ consent is received, or if the two-year extension of the AIF is complete without investor approval for in-specie distribution of  residual  assets, the  AIF  shall  fully  liquidate the  scheme within  one year following expiration of the fund tenure.

d. Large Value Funds for Accredited Investors (‘LVF’) are permitted to extend the tenure  beyond  two  years,  subject  to  terms  of  the  contribution  agreement,  other fund documents and such conditions as may be specified by SEBI from time to time. In   case the requisite   conditions   specified   in   the   placement   memorandum, contribution agreement or other fund documents  of  LVF  for  extension  of  tenure beyond two years are not fulfilled, the LVF shall fully liquidate in accordance with AIF Regulations.

SEBI has, in the recent past, received requests/ intimation from a few AIFs regarding extension of the tenure of their schemes citing reasons such as lack of liquidity, legal/regulatory impediments, etc.

Sample data collected by SEBI for expiry of the tenure of schemes  of AIFs suggests  that the  two-year  extension  period  for 24 schemes of  AIFs with a valuation of INR 3,037crores will expire in FY 2023-24. Further, the tenure of another 43 schemes with a valuation of Rs 13,450 crores will expire in FY 2024-25.

At the end of the tenure of a scheme which has a term exceeding two years, and at the end of extended tenure of LVFs, the AIF/manager may close the existing scheme and transfer the unliquidated investments to a new scheme, subject to obtaining consent of 75% of  investors  by value, provided that:

a. The AIF/manager must arrange bids for a minimum of 25% of the unliquidated investments to provide exits to the investors who do not wish to continue in the new scheme.  The AIF/manager shall offer pro-rata exit to all participating investors who choose to redeem their units through this option.

b. The value at which the aforementioned exit is proposed to be provided to such investors, along with the valuation carried out by two independent valuation agencies, shall be disclosed to all investors.

c. If the minimum 25% bid is obtained from related parties of the AIF/manager/ sponsor or from other existing investors, the same should be  transparently disclosed to all investors. Such bids can only be used to provide pro-rata exit to other remaining investors.

d. In case such fresh bids for a minimum of  25%  of  unliquidated  investments cannot be arranged, the closing valuation of the scheme will be based on the liquidation  value  as  determined under  IBBI  (Insolvency  Resolution Process  for Corporate Persons) Regulations, 2016, or other applicable IBC norms.

e. Performance of the fund managers shall be computed in accordance with the value at which investors are provided exit or liquidation value, as the case may be. 

f. In setting up the new fund, fresh investors will be explicitly informed that the new scheme holds unliquidated investments from a previously closed scheme and the reasons thereof.

g. If such new scheme has been launched with the objective to only  transfer unliquidated   investments   from   old   scheme, and   not   to   make   any   new investment, then such scheme shall be exempted from certain provisions of AIF Regulations, such as minimum  scheme corpus requirement, minimum   investment   requirement   from   investor and requirement of fixed tenure.

In case  the  consent  of  75%  of  investors  by  value  is  not  received  either  for  in-specie distribution or for transfer to a new scheme in accordance with the terms proposed above, the AIF/manager shall mandatorily liquidate the investments at liquidation value within a year of expiry. The manager  and  trustee  shall  be  responsible  for  compliance  with  the  aforesaid procedure.

Buying/selling investments to /from “associates” of AIF

AIFs, in their normal course  of  business,  may  deal  with  their  “associates”  for  various purposes  including  investing  in  associates,  buying/selling  of  securities  to/from associates, availing services of associates etc.

With respect to dealing  with  associates,  the  following  norms have  been specified under AIF Regulations:

a. AIF shall not invest, except with the approval of 75% of investors by value of their investment in the AIF, in (a) associates; or (b) units of AIFs managed or sponsored by its Manager, Sponsor or associates of its Manager or Sponsor.

b. Special Situation Funds and Angel funds shall not invest in associates.

c. Managers and  Sponsors  of  AIFs  shall  abide  by  high  level  principles  on avoidance of conflicts of interest with associated persons, as may be specified by SEBI from time to time.

d. Any fees charged  to  the AIF or  any  investee  company  by an  associate  of the Manager or Sponsor shall be disclosed periodically to the investors.

Similar to investment in associates, buying or selling of securities from/to associates and schemes  of  AIFs  managed/sponsored  by  the  same  manager/sponsor or  their associates may  also  have  conflict  of  interest  issues. 

An AIF shall not buy or sell investments, except with the approval of 75% of investors by value of their investment in the AIF, from or to a) associates; or b) schemes of AIFs managed or sponsored by its Manager, Sponsor or their associates.