Regulatory Alert: SEBI amends AIF Regulations on concentration norms and co-investment provisions

Background

Securities and Exchange Board of India (SEBI), the Indian capital market regulator, recently amended¹ the SEBI (Alternative Investments Funds) Regulations, 2012 (Regulations) that had laid down regulatory provisions for Alternative Investment Funds (AIF) in India. The amendments pertain to the following:

• Permitting Category-III AIFs to compute Net Asset Value (‘NAV’) based concentration norms for investment in listed equity shares; and
• Strengthening provisions in relation to co-investment by manager, sponsor or investor of Category-I AIF and Category-II AIF.

Thereafter, the SEBI issued a Circular² clarifying certain aspects of the amendment in the Regulations.

We, at BDO in India, have analysed and summarised the aforementioned amendments and clarifications issued hereunder:

Net Asset Value (NAV) based concentration norms for Category-III AIF

Erstwhile Methodology

The Regulations provided for investment in an investee company based on specified concentration norms. As per the Regulations, investments by Category-III AIFs have been restricted at 10% of the investible surplus of the AIF for investment in an investee company, either directly or through investment in other AIFs. In case of large value funds for accredited investors of the AIF, the Regulations specify the limit at 20%.

In this regard, the Regulations define the term “investable funds” as corpus of the scheme of AIF net of expenditure for administration and management of the fund estimated for the tenure of the fund.

Present Changes in the Methodology

The SEBI has now substituted the above mechanism to allow Category-III AIFs to compute the concentration norms based on the NAV of the AIF, instead of the investible funds. However, this amendment was introduced in relation to investment in only listed equity shares of an investee company and investment in any other securities shall continue as per the pre-amended regulations.

The SEBI Circular clarified the mechanism of computation of the concentration norms. The key aspects of the Circular are summarised below:

• Computation methodology: The limit for investment in listed equity shall be calculated based on the NAV of the fund on the business day immediately preceding the date on which the Category-III AIF makes such investment.
• How to compute the NAV?:
  • Inclusions:
    • Sum of the value of all securities adjusted for mark-to-market gains/losses
    • Cash and cash equivalents).
  •  Exclusions: Any funds borrowed by the AIF.

• Regularisation of passive breach of concentration norms: In case the market value of the investment of Category-III AIF in listed equity of an investee company exceeds the prescribed investment limit, the same shall be rectified within 30 days from the date of the breach.

Co-investment by Manager, Sponsor, or Investor of Category-I AIF and Category-II AIF

The SEBI has also amended the Regulations to introduce definition of the term ‘co-investment’. As per the amended Regulations, ‘co-investment’ means investment made by a Manager or Sponsor or investor of Category I and II AIF(s) in investee companies where such Category I or Category II AIF(s) make investment. The definition further states that the co-investment by investors of AIF shall be through a co-investment Portfolio Manager as specified under the Securities and Exchange Board of India (Portfolio Managers) Regulations, 2020 (‘Portfolio Manager Regulations’).

Further, the Regulations earlier stated that co-investment in an investee company by a Manager or Sponsor shall not be on terms more favourable than those offered to the AIFs. The amended Regulations now prescribe the following:

• The terms offered to co-investor, shall not be more favourable than the terms of investment of the AIF; and
• The terms of exit from the co-investment in an investee company including the timing of exit shall be identical to the terms applicable to that of exit of the AIF.

The amendment also states that the condition on the terms of exit shall be applicable only for co-investment made from the date of coming into force of this regulation i.e. 9 December 2021.

In order to regulate the co-investment through the consolidated portfolio manager route, the SEBI also amended³ Portfolio Manager Regulations to insert the definition of the term ‘Co-investment Portfolio Manager’.

As per the said amended regulations, a Co-investment Portfolio Manager means a Portfolio Manager who is a Manager of a Category I or Category II AIF(s); and

• provides services only to the investors of such Category I or Category II AIF(s); and
• makes investment only in unlisted securities of investee companies where such Category I or Category II AIF(s) make investments.

The definition further states that the Co-investment Portfolio Manager may provide services to investors from any other Category I or Category II AIF(s) which are managed by them and are also sponsored by the same Sponsor(s).

A few other relevant amendments have been made in the Portfolio Manager Regulations in relation to the above.

In relation to the above, the SEBI Circular specified that the requirement of appointment of a custodian shall be applicable if the sum of the corpus of the AIF and the value of the co-investment managed by the Manager of the AIF as Co-investment Portfolio Manager exceeds INR 5bn. This is in line with the requirement under the Regulations to appoint a custodian for safekeeping of the securities if the corpus of the AIF is more than INR 5bn.

BDO Comments

The above amendments in relation to concentration norms will have a two-fold effect. From the AIF perspective, the above amendments promote a more flexible approach to investment in an investee company by changing the basis of computation for concentration norms from a static investible surplus base to a market driven approach via the NAV base. On the regulatory side, the amended regulations will allow the SEBI to ensure that in case of any plunge in the capital markets, the investment in any investee company is not greater than the prescribed percentage, even when the investible surplus is in excess of the NAV of the AIF. Thus the fund with need to re-balance its portfolio with each and every market movement.

Further, the amendment in relation to co-investment seeks to regulate the co-investment model of Category-I and Category-II AIFs and also provide more clarity on terms of co-investment.

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