The Securities and Exchange Board of India (‘‘SEBI’’) has issued the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012, for regulating the activities of the unregulated private pool of money by the Alternative Investment Fund (AIF) route. The regulations came into force on 21st May, 2012. On and from the commencement of the regulations, no entity or person shall act as an Alternative Investment Fund, unless it has obtained a certificate of registration from the SEBI.

What is Alternate Investment Fund?

Alternative Investment Fund means any fund established or incorporated in India in the form of a trust or a company or a limited liability partnership or a body corporate which

(i) is a privately pooled investment vehicle which collects funds from investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors

Note: The regulations exclude few persons from the application of the regulations. Such as, Specific Family Trusts, ESOP trusts (conditions), Employee welfare trusts, Gratuity Trusts, holding companies‘ within the meaning of Section 4 of the Companies Act, 1956, securitisation trusts, securitisation company, reconstruction company registered with RBI, any such
pool of funds which is directly regulated by any other regulator in India.

Why Registration

No entity or person shall act as an Alternative Investment Fund unless it has obtained a certificate of registration from the SEBI.

An existing fund falling within the definition of Alternative Investment Fund which is not registered with the SEBI may continue to operate if it has made an application for registration under sub-regulation (5) till the disposal of such application.

Existing schemes will be allowed to complete their agreed tenure, such funds shall not raise any fresh monies other than commitments already made till registration is granted under regulation 6.

What About Existing Venture Capital Funds

The funds registered as venture capital fund under SEBI (Venture Capital Funds) Regulations, 1996 shall continue to be regulated by the said regulations till the existing fund or scheme managed by the fund is wound up and such funds
shall not launch any new scheme after notification of these regulations.

However, the existing fund or scheme shall not increase the targeted corpus of the fund or scheme.

Venture capital funds may seek re-registration under these regulations subject to approval of two-thirds of their investors by value of their investment.

Categories of Funds and their Registration Aspects

1. Alternative Investment Funds shall seek registration in one of the categories mentioned hereunder and in case of Category I Alternative Investment Funds, they need to apply in one of the sub-categories thereof

1. Category I Alternative Investment Fund: These are funds which invests in start-up or early stage ventures or social ventures or SMEs or infrastructure or other sectors or areas which the Government or regulators consider as socially or economically desirable and shall include venture capital funds, SME funds, social venture funds, infrastructure funds and such other Alternative Investment Funds as may be specified

2. Category II Alternative Investment Fund:– Funds which does not fall in Categories I and III and which does not undertake leverage or borrowing other than to meet day-to-day operational requirements and as permitted in these regulations; Explanation.– For the purpose of this clause, Alternative Investment Funds such as private equity funds or debt funds for which no specific incentives or concessions are given by the Government or any other Regulator shall be included.

3. Category III Alternative Investment Fund:– Funds which employs diverse or complex trading strategies and may employ leverage including through investment in listed or unlisted derivatives. Explanation.– For the purpose of this clause, Alternative Investment Funds such as hedge funds or funds which trade with a view to make short-term returns or such other funds which are open ended and for which no specific incentives or concessions are given by the Government or any other Regulator shall be included.

Definitions

The regulations also provide clarity by defining following important terms.

1. Manager means any person or entity who is appointed by the Alternative Investment Fund to manage its investments by whatever name called and may also be same as the sponsor of the Fund

2. Sponsor means any person or persons who set up the Alternative Investment Fund and includes promoter in case of a company and designated partner in case of a limited liability partnership

3. Associate means a company or a limited liability partnership or a body corporate in which a director or trustee or partner or Sponsor or Manager of the Alternative Investment Fund or a director or partner of the Manager or Sponsor holds, either individually or collectively, more than fifteen per cent of its paid-up equity share capital or partnership interest, as the case may be

4. Debt fund means an Alternative Investment Fund which invests primarily in debt or debt securities of listed or unlisted investee companies according to the stated objectives of the Fund

5. Hedge fund means an Alternative Investment Fund which employs diverse or complex trading strategies and invests and trades in securities having diverse risks or complex products including listed and unlisted derivatives

6. Infrastructure fund means an Alternative Investment Fund which invests primarily in unlisted securities or partnership interest or listed debt or securitised debt instruments of investee companies or special purpose vehicles engaged in or formed for the purpose of operating, developing or holding infrastructure projects; Explanation.– Infrastructure shall be as defined by the Government of India from time to time

7. Private equity fund means an Alternative Investment Fund which invests primarily in equity or equity linked instruments or partnership interests of investee companies according to the stated objective of the fund

8. SME fund means an Alternative Investment Fund which invests primarily in unlisted securities of investee companies which are SMEs or securities of those SMEs which are listed or proposed to be listed on a SME exchange or SME segment of an exchange

9. Social venture fund means an Alternative Investment Fund which invests primarily in securities or units of social ventures and which satisfies social performance norms laid down by the fund and whose investors may agree to receive restricted or muted returns.

10. Venture capital fund means an Alternative Investment Fund which invests primarily in unlisted securities of start-ups, emerging or early-stage venture capital undertakings mainly involved in new products, new services, technology or intellectual property right based activities or a new business model.

Eligibility Criteria

1. Constitution document need to specifically permit to carry on the activity of an Alternative Investment Fund.

2. Constitution document prohibits to invite application for subscription to its securities.

3. Constitution document is registered under relevant regulatory statute.

4. Applicant, sponsor and manager are fit and proper persons based on specified in Schedule II of the Securities and Exchange Board of India (Intermediaries) Regulations, 2008.

5. Sponsor to state investment strategy, investment purpose and its investment methodology in its placement memorandum to the investors.

6. Material alteration in strategy shall be made with the consent of at least two-thirds of unit holders.

7. Key investment team should have adequate experience with at least one key personnel having not less than five years’ experience in advising or managing pools of capital or in fund or asset or wealth or portfolio management or in the business of buying, selling and dealing of securities or other financial assets and has relevant professional qualification.

8. Manager or sponsor should have necessary infrastructure and manpower in place.

9. The applicant has clearly described at the time of registration the investment objective, the targeted investors, proposed corpus, investment style or strategy and proposed tenure of the fund or scheme;

Conditions of Certificate

1. AIF shall not carry on any other activity other than permitted activities.

2. They shall intimate SEBI if any information found to be misleading or false, or if there is any material change in the information already submitted.

3. Approval of SEBI required for subsequent change in category.

Investment Strategy

As stated earlier, all Alternative Investment Funds shall state investment strategy, investment purpose and its investment methodology in its placement memorandum to the investors and any material alteration to the fund strategy shall be made with the consent of at least two-thirds of unit holders by value of their investment in the Alternative Investment Fund.

Investment Conditions and Restrictions

1. Funds can be raised only by issue of Units, from Investors, whether Indian, foreign or non-resident Indian investors.

2. Each scheme shall have minimum corpus of ` 20 crores.

3. Minimum investment by an investor shall be ` 1 crore (the minimum limit is ` 25 lakhs in case of Employees, Directors of the Investment fund or the manager).

4. The manager or sponsor shall have interest in the fund not less than lower of 2.5% of the corpus or ` 5 crores. (in case of Category III AIF, the same is 5% and ` 10 crore respectively).

5. A scheme can have 1,000 maximum number of investors.

6. AIF cannot solicit or collect funds except by way of private placement by issue of information memorandum or placement memorandum, by whatever name called.

7. Manager and sponsor of AIF to disclose their interest in the AIF to the investors.

Placement Memorandum

Alternative Investment Fund shall raise funds only through private placement by issue of information memorandum or placement memorandum to the investors. The regulations specify the mandatory contents of the information memorandum/placement memorandum. Such as

1. It shall contain all material information about the AIF and the manager, background of key investment team of the manager.

2. Information about targeted investors, fees and all other expenses proposed to be charged, tenure of the Alternative Investment Fund or scheme, conditions or limits on redemption, investment strategy, risk management tools and parameters employed, key service providers, conflict of interest and procedures to identify and address them, disciplinary history, the terms and conditions on which the manager offers investment services, its affiliations with other intermediaries, manner of winding up of the Alternative Investment Fund or the scheme and such other information as may be necessary for the investor to take an informed decision on whether to invest in the Alternative Investment Fund.

3. All Alternative Investment Funds shall state investment strategy, investment purpose and its investment methodology.

AIF need to file placement memorandum 30 days prior to launch of any scheme along with fees (For first scheme of AIF, no fees to be paid). Comments of SEBI, if any, shall be incorporated in placement memorandum prior to launch of scheme.

Tenure of the Funds

1. Category I & II AIF shall be close ended and the tenure should be determined at the time of application, Category III can be open ended or close ended.

2. Categories I & II shall have minimum tenure of three years.

3. Extension of the close ended AIF may be permitted up to 2 years subject to approval of 2/3rd of the unit holders by value.

4. If not extended as per above, the fund should be liquidated within one year after the expiration of the fund tenure or extended tenure, as the case may be.

Listing

1. Units of close ended AIFs can be listed subject to minimum tradable lot of one crore rupees.

2. Listing can be permitted only after final close of the fund or scheme.

General Investment Conditions

1. Investment in companies incorporated outside India are subject to guidelines of SEBI and RBI from time to time.

2. Co-investment by sponsor or manager shall not be on terms more favourable than the fund.

3. Categories I and II cannot invest more than 25% of the corpus in one investee company (10% for Category III).

4. AIF cannot invest in Associates except with the approval of 75% of the investors by value.

5. Un-invested portion of the fund can be kept in liquid assets (MF, Treasury Bills, CPs, CDs, CBLOs, Bank Deposits, etc.) till deployment of funds as per investment objectives.

6. AIF may act as Nominated Investor.

Conditions for Category I AIF

Conditions applicable to all Category I Investment funds,

1. It can invest in units of Category I AIF of same sub Category but cannot invest in funds of funds.

2. Category I Alternative Investment Funds shall not borrow funds directly or indirectly or engage in any leverage except for meeting temporary funding requirements for not more than thirty days, on not more than four occasions in a year and not more than ten per cent of the corpus.

Over and above the conditions, there are other conditions applicable for sub-categories of funds such as Venture Capital Funds, SME Funds, Social Venture Funds, and Infrastructure Funds.

Conditions for Category II Alternative Investment Funds

The following investment conditions shall apply to Category II Alternative Investment Funds:-

1. Category II Alternative Investment Funds shall invest primarily in unlisted investee companies or in units of other Alternative Investment Funds as may be specified in the placement memorandum.

2. Fund of Category II Alternative Investment Funds may invest in units of Category I or Category II Alternative Investment Funds, provided that they shall only invest in such units and shall not invest in units of other Funds.

3. Category II Alternative Investment Funds cannot borrow funds directly or indirectly and shall not engage in leverage except for meeting temporary funding requirements for not more than thirty days, not more than four occasions in a year and not more than ten per cent of the corpus;

4. Notwithstanding clause (c), Category II Alternative Investment Funds may engage in hedging, subject to guidelines as specified by the SEBI from time to time.

5. Such funds may enter into an agreement with merchant banker to subscribe to the unsubscribed portion of the issue or to receive or deliver securities in the process of market making of SME shares.

Conditions for Category III Alternative Investment Funds

1. Category III Alternative Investment Funds may invest in securities of listed or unlisted investee companies or derivatives or complex or structured products.

2. Fund of Category III Alternative Investment Funds may invest in units of Category I or Category II Alternative Investment Funds, provided that they invest solely in such units and shall not invest in units of other Funds.

3. Such Fund may engage in leverage or borrow subject to consent from the investors in the fund and subject to a maximum limit, as may be specified by the SEBI. Provided that such funds shall disclose information regarding the overall level of leverage employed, the level of leverage arising from borrowing of cash, the level of leverage arising from position held in derivatives or in any complex product and the main source of leverage in their fund, to the investors and to the SEBI periodically, as may be specified by the SEBI.

4. Shall be regulated through issuance of directions regarding areas such as operational standards, conduct of business rules, prudential requirements, restrictions on redemption and conflict of interest as may be specified by the SEBI.

General Conditions and Responsibilities and Transparency requirements

Following are general conditions and responsibilities of AIFs including requirements for the purpose of maintaining transparency in operations.

1. The Sponsor or Manager of Alternative Investment Fund shall appoint a custodian registered with the Board
   for safekeeping of securities if the corpus of the Alternative Investment Fund is more than five hundred crore rupees.

2. The Sponsor or Manager of Category III AIF needs to appoint custodian irrespective of the size of the corpus.

3. Prior approval of SEBI required in case of change in control of the Alternative Investment Fund, Sponsor or Manager.

4. Books of account of all AIFs to be audited by qualified auditors.

5. Sponsor and Manager of the AIF shall act in a fiduciary capacity for its investors and shall disclose all conflicts of interest as and when they arise or seem likely to arise.

6. Managers shall establish and implement written policies and procedures to identify, monitor and appropriately mitigate conflicts of interest throughout the scope of business.

7. Conflict of interests to be disclosed and managed and mitigated as per laid down policies.

8. Ensure transparency and disclosure of information to investors on various matters such as financial, risk management, operational, portfolio, and transactional information regarding fund investments, any enquiries or legal actions against the fund, any material liability arising, any breach of provisions of placement memorandum or agreement with the investors, change in control of sponsor or manager or investee company.

9. AIF shall provide information on specified matters on annual basis within 180 days from the year end e.g. financial information, material risks and how they are managed.

10. Category III AIF provides quarterly reports to investors in respect of above clauses within 60 days of end of the quarter.

11. Significant change in key investment team to be intimated to all the investors.

12. AIF shall provide description of valuation methodologies and procedure for valuing assets.

13. Categories I and II AIF shall undertake valuation of their investments, at least once in every six months, by an independent valuer appointed by the AIF. Period may be enhanced maximum up to 1 year subject to approval of at least 75% of investors by value.

14. Category III AIF shall ensure that calculation of NAV is independent from the fund management function and such NAV shall be disclosed to the investors at intervals not longer than a quarter for close ended funds
    and at intervals not longer than a month for open ended funds.

Obligations of Manager

Manager shall be obliged to

1. Address all investor complaints.

2. Provide information to SEBI any information sought.

3. Maintain records as may be specified by SEBI.

4. Take all steps to address conflict of interest as specified in these regulations.

5. Ensure transparency and disclosure as specified in the regulations.

Dispute Resolution

AIF shall lay down procedure for resolution of disputes between the investors, Alternative Investment Fund, Manager or sponsor through arbitration or any such mechanism as mutually decided between the investors and the AIF.

Maintenance of Records

The manager or sponsor shall be required to maintain records describing

1. The assets under the scheme/fund

2. Valuation policies and practices

3. Investment strategies

4. Particulars of investors and their contribution

5. Rationale for investments made.