Corporate Law Newsletter – The Securities and Exchange Board of India (Alternative Investment Funds) (Amendment) Regulations, 2024 along with The SEBI Guidelines for AIF : Feb 2024

Introduction

The Securities and Exchange Board of India (“SEBI”), vide notification dated January 05, 2024 has introduced amendments to the SEBI (Alternative Investment Funds) Regulations, 2012 “AIF Regulation” and have issued SEBI (Alternative Investment Funds) (Amendment) Regulations, 2024 “Amendment”, in order to facilitate ease of compliance and to strengthen investor protection in Alternative Investment Funds (“AIFs”).

Further, SEBI vide circular dated January 12, 2024, has issued the SEBI Guidelines for AIFs “SEBI AIF Guidelines” to enhance clarity of compliance with respect to AIFs holding their investments in dematerialised form and appointment of custodian. The amendments introduced by the aforesaid notification and the guidelines issued by SEBI are as follows: 

Holding investments of AIFs in dematerialized form

Regulation 15 of the AIF Regulation establishes the principles for general investment conditions for AIFs. By virtue of this Amendment, all AIFs under Regulation 15 shall now hold their investments in dematerialised form, subject to the conditions specified by SEBI from time to time. The mandatory dematerialisation does not apply, inter-alia, to such investments by AIFs and schemes of AIFs as may be specified by SEBI from time to time. The key changes of the said Amendment  are as follows:

• Fresh Investments – Any investment made by an AIF on or after October 01, 2024 shall be held in dematerialised form irrespective of whether the investment is made directly in the investee company or is acquired from another entity.

• Existing Investments – The existing investments made by an AIF have been exempted, except in cases:
  • Investee company is required to facilitate the dematerialisation of its securities under applicable law. 
  • Investment in dematerialised form, has control over the investee company, where the AIF, on its own, or along with other SEBI registered intermediaries/ entities are mandated. For the purpose of the aforesaid clause, the definition of ‘control’ shall be construed with reference to Regulation 2(1)(f) of AIF Regulations. However, the said requirement of holding investments in dematerialised shall not be applicable to the following:
    • AIF schemes whose tenure (not including the permissible extension of tenure) ends on or before January 31, 2025; and 
    • AIF schemes whose tenure has been extended as on the date of issuance of this amendment.

Appointment of custodian for AIFs

Regulation 20 of the AIF Regulation, encompasses the general obligations, responsibilities, and transparency has been amended further, and by virtue of this Amendment. The amended Regulation 20 now requires every AIF to appoint a ‘Custodian’ which is registered with SEBI for safekeeping of the securities of the AIFs, in the manner as may be specified by SEBI from time to time. However, the Custodian appointed by the Sponsor or Manager of a Category III AIF shall be responsible for maintaining custody of the securities and goods received in delivery against the physical settlement of commodity derivative.

Further, under Regulation 20(11A) the Custodian which is an associate of the Sponsor or Manager of an AIF may act as a Custodian for that AIF only when all the following conditions are met:

• the Sponsor or Manager has a net worth of at least twenty thousand crore rupees at all points of time;
• fifty per cent or more of the directors of the Custodian do not represent the interest of the Sponsor or Manager or their associates;
• the Custodian and the Sponsor or Manager of the AIF are not subsidiaries of each other;
• the Custodian and the Sponsor or Manager of the AIF do not have common directors, and
• the Custodian and the Manager of the AIF sign an undertaking that they shall act independently of each other in their dealings of the schemes of the AIF.

A significant clause in the aforementioned SEBI Guidelines, states that as of the date of this circular, i.e January 12, 2024, all existing Category I and II AIF schemes with capital not exceeding INR 500 (five hundred) crore and having at least one investment must mandatorily designate a Custodian by January 31, 2025. An AIF may appoint a custodian who is an associate of the manager or sponsor of the AIF, permitting the related party or sponsor of a mutual fund to act as its custodian, as conditions prescribed under SEBI (Mutual Funds) Regulations, 1996. 

Reporting of investments of AIFs under custody 

Under Regulation 20(11) of AIF Regulations, the pilot Standard Setting Forum (“SFA”) for AIFs, in consultation with SEBI, shall formulate implementation standards which shall specify the format and modalities of reporting of data by the manager of AIF to the custodian and subsequently, by the custodian to SEBI for reporting data on investments that are under custody.
The Managers and Custodians of AIFs, within 60 days of the issuance of the said SEBI Guidelines, are required to adopt the implementation standards which will then be made available on the websites of the industry associations which constitute a part of the Standard Setting Forum, namely the Indian Venture and Alternate Capital Association (‘IVCA’), Private Equity, Venture Capital, CFO Association, and Trustee Association of India. 

The trustee/sponsor of AIF shall ensure that the ‘Compliance Test Report’ prepared by the manager of the AIFs is in terms with the SEBI Master Circular dated July 31, 2023, which includes compliance with the provisions of this SEBI Guidelines. The information necessary to ascertain compliance with the provisions of this amendment shall be incorporated in the format for quarterly reporting by AIFs in the SEBI Intermediary Portal (www.siportal.sebi.gov.in).

Conclusion

The Amendment Regulation introduced by SEBI is expected to make compliance easier and strengthen India’s investment landscape. The guidelines which focus on dematerialised investments and custodian appointments, constitute a step forward in improving the transparency and security of the Alternative Investment Fund.