Introduction

The Securities and Exchange Board of India (“SEBI”) has issued 3 interpretative letters under the SEBI (Informal Guidance) Scheme, 2003 providing guidance on certain operational aspects of Alternative Investment Funds (“AIFs”). A summary analysis of the same is provided below.

Please note that while the interpretative letters may be considered to be reflecting SEBI’s viewpoint on  the issues raised before it, and that SEBI may generally be expected to act in accordance with it, the interpretative letters are not binding on SEBI.

• Informal guidelines given to IIFL Asset Management Ltd on November 06, 2018

The query concerned the lock-in period of the pre-issue capital held by a Category II AIF, applicable to  the listed shares held by it. As a background, under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009 (“ICDR Regulations”), the entire pre-issue capital of non-promoter shareholders is locked-in for a period of 1 year from the date of allotment in the IPO process; there is an exemption granted, inter alia, to Category I and II AIFs from the lock-in requirement in respect of their equity holdings, provided that such equity shares are locked-in for a period of at least 1 year from the  date of purchase (“Tenure to Avail Exemption”). The query arose when the National Stock Exchange (“NSE”) and Bombay Stock Exchange (“BSE”) interpreted the ICDR Regulations to mean that the date of the Tenure to Avail Exemption commences from the date of allotment in the IPO process instead of date of purchase, for Category I and II AIFs.

SEBI’s guidance was sought on whether the date of commencement of the Tenure to Avail Exemption would be the date of allotment in the IPO process, or the date of purchase of the concerned shares by the querist AIF.

SEBI clarified that the lock-in period starts from the date of purchase of the equity shares by the querist AIF, and that once equity shares have been held for the Tenure to Avail Exemption the lock-in would not apply.

AZB Analysis: This clarification is in line with the generally accepted interpretation of the exemption condition and it should help Category I and II AIFs to deal with any such queries or questions being raised by the NSE and BSE going forward.

• Informal guidance given to KellyGamma Advisors LLP on January 10, 2019

The query referred to SEBI was pertaining to the computation of the amounts available to be invested by  a Category III AIF in a single investee company. As per the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”), Category III AIFs are permitted to invest up to 10% of their

‘investible funds’1 in a single investee company. However, the querist AIF sought clarifications from SEBI on whether the gains generated by the AIF from sale of existing portfolio investments should be  computed towards their ‘investible funds’. Inclusion of the gains would result in increase of the amounts of ‘investible funds’, which would increase the amount available to the AIF for investments in a single investee company.

SEBI, while referring to the definition of the term ‘investible funds’ under the AIF Regulations, did not consider the gains while computing ‘investible funds.’

AZB Analysis: The interpretation adopted by SEBI in computing ‘investible funds’ of the querist AIF confirms that the profits or losses arising to the AIF from its investments, or a change in the assets under management (“AUM”), should not be factored in while computing ‘investible funds’ of an AIF. While the guidance is issued in context of a Category III AIF, one may understand it to mean that any change in the AUM of an AIF (irrespective of category) would not impact its ‘investible funds’ and consequently its ability to make investments in investee companies remains unaffected from any changes to its AUM.

• Informal guidance given to JM Financial Limited on October 17, 2018

The query referred to SEBI was pertaining to whether a Category II AIF can invest the distribution proceeds generated upon a Category II AIF’s exit from its portfolio investments in temporary investment,2 pending the distributions of such proceeds to their investors. This clarification was sought in light of the

fact that while the AIF Regulations categorically permit AIFs to make temporary investments from un- invested portions of investible funds, the AIF Regulations do not specifically permit the investments of distribution proceeds generated upon the AIF’s exit from its portfolio investments in any temporary investments.

SEBI noted that the AIF Regulations permit AIFs to make temporary investments from un-invested portions of investible funds, since such deployment of funds is in the interest of the investors. SEBI observed that the same rationale should also be applicable to the deployment of distribution proceeds in temporary investments pending distributions to the investors. Therefore, SEBI observed that such investment of distribution proceeds in temporary investments pending the distribution of such proceeds to their investors by the querist AIF was permitted.

AZB Analysis: While in most cases, funds distribute the returns or proceeds generated from the sale of their investments to the investors since the same is generally in the best interest of both the limited partners and the general partners. However, there may be extenuating circumstances (for example, an expected or contingent liability fructifying, or a tax or statutory claim), in which case the fund managers may be required to retain distributable proceeds in the fund for a temporary period. In such cases, the investments of such distribution proceeds pending distributions to the investors in temporary investments would be in the best interest of the investors.

SEBI’s interpretation keeps in mind the interest of the investors as well as gives operational flexibility to fund managers.

1 Defined in AIF Regulations under section 2 (p) as “corpus of the Alternative Investment Fund net estimated expenditure for administration and management of the fund.”

2  Temporary investments may include liquid mutual funds or bank deposits or other liquid assets of higher quality such as Treasury bills, CBLOs, Commercial Papers, Certificates of Deposits, etc.