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Regulatory Alert: Alternative Investment Funds - PPM Template and Performance Benchmarking Guidelines notified

10 February 2020

The Alternative Investment Fund (‘AIF’) industry has been regulated by Securities and Exchange Board of India (‘SEBI’) vide the issuance of the SEBI (AIF) Regulations, 2012 (‘AIF Regulations’). SEBI has subsequently issued clarifications on various aspects of the AIF Regulations. Amongst these was SEBI Circular dated 19 June 2014 [CIR/IMD/DF/14/2014], which laid down certain disclosure requirements in the Private Placement Memorandum (‘PPM’) issued by AIFs, such as a detailed tabular example the distribution waterfall for investors.

With a view to further systemize and streamline disclosure standards for AIFs, SEBI, through a Consultation Paper dated 4 December 2019 sought public comments on ‘Introduction of Performance Benchmarking’ and ‘Standardization of Private Placement Memorandum for AIFs’.

In this regard, taking into consideration the inputs from public consultation and deliberations in Alternative Investment Policy Advisory Committee (AIPAC), SEBI has now released a Circular dated 5 February 2020 notifying certain disclosure Standards for AIFs. The Circular provides a template for PPM for all categories of AIF and Operational Guidelines for mandatory performance benchmarking of AIF industry.

Key Highlights 

Template for PPM

  • The PPM being a critical document for prospective investors, the Circular mandates a template for the PPM to ensure disclosure of essential information and comparability between PPMs issued by various AIFs.
  • Broadly, the PPM template encapsulates various disclosures, including fund structure, governance, critical terms, risk factors and distribution waterfall. The PPM template prescribes two parts:
    • Part A: Section for minimum disclosures; and
    • Part B: Supplementary section for flexibility to disclose additional information.
  • The Circular provides a common template for Category – I and Category – II AIFs and a separate template for Category – III AIFs.
  • Some of the additional prescribed minimum disclosures as required in the template PPM include the following:
    • Track record of Manager;
    • Principles of Portfolio Valuation for Category - I and Category - II AIFs;
    • Aspects for determination of NAV of Units for only Category - III AIFs.
  • The Circular also mandates the terms of contribution / subscription agreements to be aligned with and not go beyond the terms of the PPM.

Annual Compliance Audit

  • In order to ensure compliance by the AIF with PPM terms, mandatory annual audit has been prescribed vide the Circular. The audit is to be carried out by an internal or external auditor or a legal professional.
  • Annual audit of the following section in a PPM is optional:
    • Risk factors;
    • Legal regulatory and tax considerations; and
    • Track Record of First Time Managers.
  • The findings of such audit along with any corrective steps, are to be communicated to the Trustee / Board / Designated Partners of the AIF, Board of the Manager and SEBI.

Exemptions to certain funds

  • The Circular provides exemptions to the following from adherence with PPM template and annual audit:
    • Angel Funds as defined in the AIF Regulations;
    • AIFs / Schemes with minimum commitment of INR 70 crore from each investor, subject to obtaining a waiver from the investors in the prescribed form.

The above requirements shall be applicable with effect from 1 March 2020.

Performance benchmarking of AIFs

  • The Circular recognizes the need to develop an industry benchmark for comparing performance of AIFs against other investment avenues. Accordingly, the Circular has introduced the following:
    • Mandatory benchmarking of the performance for AIFs (including Venture Capital Funds) and the AIF industry.
    • A framework to facilitate the use benchmarking data collected by Benchmarking Agencies to provide customized performance reports.
  • In relation to the above, the following mandate is laid down by the Circular:
    • In order to carry out the benchmarking process, an AIF shall enter into an agreement with Benchmarking Agencies to be notified by any association of AIFs which represents atleast 51 percent of the number of AIFs. The said agreement shall cover aspects data collection, reporting and confidentiality.
    • The form and format of the report shall be mutually decided by the AIF and the Benchmarking Agency.
    • Every AIF completing one year from the first close of its scheme will need to report the relevant information to Benchmarking Agencies.
    • Where past performance of an AIF is sought to be provided in a PPM or any marketing material, the same shall be compared to the industry benchmark provided by the Benchmarking Agency.
    • Where investor reports cover comparison of AIF performance with any benchmarking, the Benchmarking Agency’s report backing up the same shall be provided.
    • The association of AIFs and the Benchmarking Agencies are required to make available the first industry benchmark and AIF level performance versus Benchmark Reports by 1 July 2020, for the performance until 30 September 2019. A monthly progress report shall also be submitted with SEBI till the creation of first industry benchmark.
  • The Circular also provides Operational Guidelines for implementation of performance benchmarking as well as creation of customized performance reports.
  • AIFs are required to provide data on cash flows and valuation of their scheme-wise investments to the Benchmarking Agencies on a half-yearly basis for Performance Benchmarking purpose.
  • The performance reporting and benchmarking shall be carried out on pre-tax Net Asset Value (NAV) of the Scheme.
  • The Operational Guidelines also permit creation of additional performance benchmarks, basis other parameters considering diversity in investment strategies and avenues.
  • Angel Funds registered under AIF Regulations as Venture Capital Funds under AIF Category - I have been exempted from performance benchmarking compliance.

Concluding Remarks

Standardization of primary documents like PPM will help in making available sufficient information to the investors, thereby enabling them to take informed decisions regarding AIF investments. These requirements are applicable to all the applications to be filed after 1 March 2020. Hence, these requirements shall not apply to the applications already filed. However, SEBI may seek clarifications or information before giving the approval if the proposed details are not readily available from the submissions so far. Further, standardization of the PPM should also help in streamlining the approval process and should reduce the time taken by SEBI to provide approval.

Introduction of mandatory audit and communicating the corrective steps would go a long way in strengthening the investor confidence.

Further, implementation of a regular industry-wide performance benchmarking exercise resolves a long-standing ask of existing and potential investors. This will provide investors with a clear picture of likely returns on their AIF investments and help them set reasonable expectations by comparing AIF performance with other investment avenues, as also the global investment opportunities.