Debt Investments by FPIs
SEBI issued a circular on July 20, 2017, which brought about the following modifications to the existing legal framework governing investments in corporate debt by FPIs:
i. 95% of the combined corporate debt limit (‘CCDL’) will be available for FPI investment on tap, after which an auction mechanism will be initiated for allocating the remaining limits.
ii. Once such limit is exceeded, the National Securities Depository Limited and Central Depository Services Limited will direct custodians to halt further investments in corporate debt securities by FPIs, and inform BSE Limited and National Stock Exchange of India Limited to conduct an auction for allocation of the unutilised FPI corporate debt limit, provided such limit is at least Rs. 100 crores (approx. US$ 15.3 million). If the unutilised FPI corporate debt limit continues to remain lower than the above amount for 15 consecutive trading days, then an auction is to be conducted on the 16th day.
iii. The minimum bid is Rs. 1 crore (approx. US$ 153,000), and the maximum bid is for 10% of the unutilised FPI corporate debt limit. A single FPI/ FPI group cannot bid for more than 10% of the limits being auctioned.
iv. Once the unutilised FPI corporate debt limit has been auctioned, the FPIs have a utilisation period of 10 trading days to make investments, after which the unutilized FPI corporate debt limit allocated to them, reverts to the pool of free limits.
v. Investment in corporate debt by FPIs on tap and issuance of rupee denominated bonds overseas by Indian companies will again be available once the FPI corporate debt limit utilisation levels fall back to less than 92%.
vi. Investments by FPIs in unlisted corporate debt will compulsorily be in dematerialised form, and be subject to a minimum residual maturity period of three years.
Amendment to SEBI (Alternative Investment Funds) Regulations, 2012
Pursuant to the decision taken in the SEBI Board Meeting, the SEBI (Alternative Investment Funds) Regulations, 2012 have been amended with effect from January 4, 2017 as follows:
i. The upper limit of angel investors in a scheme has been increased from 49 to 200;
ii. Angel funds are permitted to invest in start-ups incorporated within five years from incorporation, which has been increased from the earlier limit of three years;
iii. The requirements of minimum investment amount by an angel fund in any venture capital undertaking has been reduced from Rs. 50,00,000 (approximately US$ 75,000) to Rs. 25,00,000 (approximately US$ 37,500), and the lock-in period of these investments has been reduced from three years to one year; and
iv. Angel funds will now be permitted to invest in securities of foreign companies, subject to the guidelines and conditions issued by the RBI and SEBI.
Amendment to SEBI (Real Estate Investment Trusts) Regulations, 2014 and SEBI (Infrastructure Investment Trusts) Regulations, 2014
Pursuant to the meeting of the SEBI board held on September 23, 2016, SEBI has amended the SEBI (Real Estate Investment Trusts) Regulations, 2014 and the SEBI (Infrastructure Investment Trusts) Regulations, 2014. Some of the key amendments include:
i. The minimum holding of the mandatory sponsor in the infrastructure investment trust (‘InvIT’) has been reduced from 25% to 15%;
ii. The existing limit of three sponsors has been removed from both regulations;
iii. The permissible investment limit for investment by real estate investment trusts (‘REIT’) in ‘under construction’ assets has been increased from 10% to 20%; and
iv. InvITs and REITs are allowed to invest in a two-level SPV holding structure, through a holding company.
Consultation Paper on Amendments/Clarifications to the SEBI (Investment Advisers) Regulations, 2013
SEBI, on June 22, 2017, issued a consultation paper on Amendments/ Clarifications to the SEBI (Investment Advisers) Regulations, 2013 (‘IA Regulations’), setting out the following key proposals:
i. Segregation between “investment advisory” services and “distribution/execution services”: To maintain a clear segregation between these two services provided by the same entity and to prevent associated conflicts of interest, SEBI has proposed amending the IA Regulations to prohibit entities offering investment advisory services from offering distribution/execution services, including in cases of banks, non-banking financial companies and body corporates that offer such services through separately identifiable departments or divisions. Such departments will be required to be segregated within a period of six months through a separate subsidiary. Entities which provide advice solely on products which do not qualify as securities have been excluded from the purview of the IA Regulations.
ii. Distribution of mutual fund schemes by distributors: To maintain a clear segregation between “advising” and “selling / distribution” of mutual fund products”, SEBI proposes that mutual fund distributors will only be permitted to explain the features of schemes of which they are distributors and distribute them while ensuring suitability of the scheme to the investors, but will not give any investment advice.
iii. Incidental advice by recognized intermediaries: Under the existing framework, exemptions from IA registration have been granted to inter alia various intermediaries, who give investment advice to their clients incidental to their primary activity. SEBI has now proposed that in order to have a clear segregation between “investment advisory services” and other services provided by such intermediaries, all intermediaries who receive separate identifiable consideration for investment advisory services will need to register with SEBI as an investment adviser. Moreover, persons who provide holistic advice/ financial planning services are compulsorily required to be registered as investment advisers.
iv. Relaxation in registration requirements: SEBI has proposed that the educational qualification requirements for representatives/employees of registered investment advisers be relaxed. It has also been proposed to reduce the net worth requirement for body corporates from Rs. 25 lakhs (approx. US$ 38,000) to Rs. 10 lakhs (approx. US$ 15,000).
v. Regulation of the activity of ranking of mutual fund scheme: SEBI has proposed that the activity of ranking of mutual fund schemes be brought within the ambit of SEBI (Research Analyst) Regulations, 2014, under a separate chapter.
FAQs in relation to the SEBI (Alternative Investment Funds) Regulations, 2012
According to the SEBI (Alternative Investment Funds) Regulations, 2012, a debt fund is permitted to invest in ‘debt or debt securities’. In the past, there was ambiguity on whether a debt fund is permitted to give loans. As per the FAQs issued by SEBI on August 18, 2016 , it was clarified that alternative investment funds are not permitted to give loans and, accordingly, loans cannot be considered under the ambit of “debt or debt securities”.
Meeting of the SEBI Board
The SEBI Board met on September 23, 2016 and took the following decisions:
i. Currently, FPIs are required to transact in securities through stock brokers registered with SEBI, while domestic institutions such as banks, insurance companies, pension funds etc. are permitted to access the bond market directly (i.e. without brokers). SEBI has decided to extend this privilege to Category I and Category II FPIs.
ii. In order to facilitate the growth of Investment Trusts (“InvIT”) and Real Estate Investment Trusts (“REIT”), SEBI has decided to amend the SEBI (Infrastructure Investment Trusts) Regulations, 2014 and the SEBI (Real Estate Investment Trusts) Regulations, 2014 (“REIT Regulations”). The key amendments will include:
a. InvITs and REITs will be allowed to invest in the two level SPV structure through the holding company subject to sufficient shareholding in the holding company and other prescribed safeguards. The holding company would have to distribute 100% cash flows realised from the underlying SPVs and at least 90% of the remaining cash flows.
b. The minimum holding of the mandatory sponsor in the InvIT has been reduced to 15%.
c. REITs have been permitted to invest upto 20% in under construction assets.
d. The limit on the number of sponsors has been removed under the REIT Regulations.
iii. The SEBI Board has approved amendments to the SEBI (Portfolio Managers) Regulations, 1993, to provide a framework for the registration of fund managers for overseas funds, pursuant to the introduction of section 9A in the Income Tax, 1961.
iv. The SEBI Board has decided to grant permanent registration to the following categories of intermediaries: merchant bankers, bankers to an issue, registrar to an issue & share transfer, underwriters, credit rating agency, debenture trustee, depository participant, KYC registration agency, portfolio managers, investment advisers and research analysts.
v. The Securities Contracts (Regulation) (Stock Exchanges and Cleaning Corporations) Regulations, 2012 have been amended to increase the upper limit of shareholding of foreign institutional investors mentioned in the Indian stock exchanges from 5% to 15% and to allow an FPI to acquire shares of an unlisted stock exchange through transactions outside of recognised stock exchange including allotment.
Foreign Investment in Units Issued by REITs, InvITs and AIFs
Salient features of foreign investment permitted by RBI, pursuant to its circular dated April 21, 2016, in the units of investment vehicles for real estate and infrastructure registered with the SEBI or any other competent authority are as under:
i. A person resident outside India (including a Registered Foreign Portfolio Investor (‘RFPI’) and NRIs may invest in units of real estate investment trusts (‘REITs’);
ii. A person resident outside India who has acquired or purchased units in accordance with the regulations may sell or transfer in any manner or redeem the units as per regulations framed by SEBI or directions issued by RBI;
iii. An Alternative Investment Fund Category III with foreign investment can make portfolio investment in only those securities or instruments in which a RFPI is allowed to invest; and
iv. Foreign investment in units of REITs registered with SEBI will not be included in ‘real estate business’.
Guidelines for Public Issue of Units of Infrastructure Investment Trusts
SEBI has, on May 11, 2016, issued Guidelines for Public Issue of Units of Infrastructure Investment Trusts (‘Guidelines’), which amend the provisions of the SEBI (Infrastructure Investment Trusts) Regulation, 2014 (‘SEBI InvIT Regulations’).
The Guidelines set out the procedure to be followed by an infrastructure investment trust (‘InvIT’) in relation to a public issue of its units, which includes the appointment of a lead merchant banker and other intermediaries, procedure for filing of offer documents with SEBI and the stock exchanges, the process of bidding and allotment. Further, the allocation in a public issue is required to be in the following proportion: (i) not more than 75% to institutional investors; and (ii) not less than 25% to other investors; provided that the investment manager has the option to allocate 60% of the portion available for allocation to institutional investors and anchor investors (which includes strategic investors), subject to certain conditions. Further, the investment manager, on behalf of the InvIT is required to deposit and keep deposited with the stock exchange(s), an amount equal to 0.5% of the amount of the units offered for subscription to the public or Rs 5 crores (approximately US$ 7,45,000), whichever is lower. The price of units can be determined either: (i) by the investment manager in consultation with the lead merchant banker; or (ii) through the book building process. However, differential prices are not permitted.
SEBI Board Meetings
SEBI, in its board meeting held on May 19, 2016, approved the incorporation of the internal guidance note in the SEBI (Settlement of Administrative and Civil Proceedings) Regulations 2014 (‘Settlement Regulations’), to clarify that only serious and substantial cases are to be taken for enforcement under Regulation 5(2)(b) of the Settlement Regulations. For this purpose, defaults which in the opinion of SEBI have a bearing on the securities market as a whole and not just the listed security and its investors may be considered to have market wide impact.
Thereafter, in its meeting held on June 17, 2016, SEBI approved the two consultation papers in relation to the changes to be made to the SEBI (Portfolio Managers) Regulations and the SEBI InvIT Regulations.
SEBI Circular on Restriction on Redemption in Mutual Funds
SEBI, on May 31, 2016 issued a circular providing details of certain specified circumstances in which mutual funds/ asset management companies/ trustees could impose restrictions on redemption of units of their mutual fund schemes. SEBI has provided that the restriction on redemption cannot exceed ten working days in any 90 day period and would be applicable for redemption requests above Rs 200,000 (approximately US$ 2,975). Further, specific approval of the board and trustees of an asset management company is required before imposing such restrictions and SEBI should be notified of such approval immediately.
Easing of access norms for investments by Foreign Portfolio Investors
SEBI has, by way of circulars dated February 15, 2018 and March 13, 2018 (collectively, the ‘FPI Circulars’), revised the regulatory framework governing foreign portfolio investors (‘FPIs’) under the SEBI (Foreign Portfolio Investors) Regulations, 2014 (‘FPI Regulations’) to ease the access norms for investments by FPIs. Some of the key changes that have come into force are set out below:
i. The current requirement of prior SEBI approval for a change in local custodian/ designated depository participant (‘DDP’) has been replaced with the requirement of obtaining a no-objection certificate from the earlier DDP, followed by a post-facto intimation to SEBI.
ii. The regime has been liberalized concerning FPIs having ‘Multiple Investment Managers’ structure and the same permanent account number, with respect to ‘Free of Cost’ transfer of assets. Approval of SEBI is now not required and DPPs are now entitled to process such requests.
iii. In case of addition of a new share class, where a common portfolio of Indian securities is maintained across all classes of shares/fund/sub-fund and broad based criteria are fulfilled at a portfolio level after adding a new share class, prior approval of the DDP is no longer required.
iv. Private banks and merchant banks are now permitted to undertake investments on behalf of their respective investors, provided that the investment banker/merchant banker submits a prescribed declaration.
v. SEBI also clarified that appropriately regulated Category II FPIs viz. asset management companies, investment managers/ advisers, Portfolio managers, Broker-dealer and Swap-dealer etc. are permitted to invest their proprietary funds.
Participation by Strategic Investor(s) in InvITs and REITs
Pursuant to SEBI’s circular dated January 18, 2018 (‘SEBI Circular’), a Real Estate Investment Trust (‘REIT’) / Infrastructure Investment Trust (‘InvIT’) may invite subscriptions from strategic investors subject to inter alia the following:
i. The strategic investors can, either jointly or severally, invest not less than 5% and not more than 25% of the total offer size.
ii. The investment manager or manager is required to enter into a binding unit subscription agreement with the strategic investors proposing to invest in the public issue, which agreement cannot be terminated except if the issue fails to collect minimum subscription.
iii. The entire subscription price has to be deposited in a special escrow account prior to opening of the public issue.
iv. The price at which the strategic investors have agreed to buy units of the InvIT/ REIT should not be less than the public issue price. In case of a lower price, the strategic investors should bring in the additional amounts within two working days of the determination of the public issue price, and in case of a higher price, the excess amount will not be refunded and the strategic investors will be bound by the price agreed in the unit subscription agreement.
v. The draft offer document or offer document, as applicable, will disclose details of the unit subscription agreement, including the name of each strategic investor, the number of units proposed to be subscribed etc.
vi. Units subscribed by strategic investors, pursuant to the unit subscription agreement, will be locked-in for a period of 180 days from the date of listing in the public issue.
Outcome of SEBI meeting held on March 28, 2018
In its meeting held on March 28, 2018, SEBI accepted the recommendations of the Kotak Committee on Corporate Governance (‘Committee’) along with certain other proposals discussed. Set out below are some of the key proposals:
i. (a) Reduction in the maximum number of listed entity directorships from 10 to (x) eight by April 1, 2019, and (y) seven by April 1, 2020; (b) expanding the eligibility criteria for independent directors; (c) disclosure of utilization of funds from qualified institutional placement or preferential issue; (d) separation of chief executive officer/managing director and chairperson (to be initially made applicable to the top 500 listed entities by market capitalization with effect from April 1, 2020); (e) enhancing the role of the audit committee, nomination and remuneration committee and the risk management committee; (f) strengthening the disclosures pertaining to related party transactions and related parties being permitted to vote against such transactions; (g) enhancing the obligations on listed entities with respect to subsidiaries; and (h) shareholder approval (majority of minority) for royalty/brand payments to related party exceeding 2% of consolidated turnover.
ii. Certain amendments to SEBI (Alternative Investment Funds) Regulations, 2012, with respect to ‘Angel Funds’: (i) Maximum investment amount in venture capital undertakings by an angel fund has been increased from Rs. 5 crores to Rs. 10 crores (approx. US$ 750,000 to US$ 1.5 million); (ii) mandatory minimum corpus of an angel fund has been reduced to Rs. 5 crores (approx. US$ 750,000); and (iii) provisions of the Companies Act have been made applicable to an angel fund, if formed as a company.
iii. Revision of the existing framework for non-compliance of the listing regulations by listed companies, inter alia, empowering the stock exchanges to freeze the shareholding of the promoter and promoter group in a non-compliant entity along with their shareholding in other securities. SEBI is empowered to order suspension if the non-compliance persists.
iv. Undertaking a public consultation process for a review of the SEBI (Buy-back of Securities) Regulations, 1998 and the Takeover Regulations and inviting comments from stakeholders in relation to compliance with various SEBI regulations by listed entities subject to the corporate insolvency resolution process under the IBC.
Finance Act, 2018
Some of the key amendments introduced by the Finance Act, 2018 (‘Finance Act’) are summarized below:
i. New long-term capital gains tax regime for listed shares etc.
• Under the unamended provisions of the Indian Income-tax Act, 1961 (‘IT Act’), with respect to transfer/redemption of units of an equity oriented mutual fund or an on-market sale of Indian equity shares (listed or as part of an initial public offer) or units of a business trust, long-term capital gains were exempt from tax in India, subject to payment of securities transaction tax (‘STT’) (which may vary from 0.001% to 0.2% of the transaction value).
• The Finance Act has withdrawn the aforesaid long-term capital gains tax exemption and has proposed a new long-term capital gains tax regime for the above asset class. Under the new regime, the long-term capital gains, in excess of Rs. 0.1 million (approx. US$ 1,500) in a tax year, arising from transfer/redemption of units of an equity oriented mutual fund or an on-market transfer of Indian equity shares (including sale of shares as part of initial public offer) will be taxed at the rate of 10% (plus applicable surcharge and cess) subject to payment of STT, as applicable as before. The computation of such capital gains will be subject to step up of the cost base till January 31, 2018. This amendment will apply on any capital gains arising on or after April 1, 2018.
ii. Scope of ‘Business Connection’ proposed to be widened:
• The scope of ‘business connection’ under the IT Act is similar to the provisions relating to Dependent Agent Permanent Establishment (‘DAPE’) in India’s Double Taxation Avoidance Agreements (‘DTAAs’). However, this scope is proposed to be widened pursuant to the Multilateral Convention to Implement Tax Treaty Related Measures to Prevent Base Erosion and Profit Shifting (‘MLI’). In order to align the scope of ‘business connection’ with the expanded definition of DAPE, the Finance Act has introduced an amendment to the definition of ‘business connection’ to also include any business activities carried through a person who, acting on behalf of the non-resident, habitually plays the principal role leading to conclusion of contracts by the non-resident. This has taken effect from the financial year beginning April 1, 2018.
• Until now, the scope of ‘business connection’ under the IT Act provided for physical presence based nexus rule for taxation of business income of the non-resident in India. Therefore, emerging business models such as digitized businesses were not covered within its scope.
In light of the above, Section 9(1)(i) of the IT Act has been amended to provide that ‘significant economic presence’ in India should also constitute ‘business connection’. This amendment in the domestic law will enable India to negotiate for inclusion of the new nexus rule in the form of ‘significant economic presence’ in the DTAAs. Unless corresponding modifications to permanent establishment rules are made in the DTAAs, the cross border business profits will continue to be taxed as per the existing DTAA rules. However, where the foreign enterprise is not entitled to a DTAA protection, the above amendment would become immediately effective. This amendment has taken effect from financial year beginning April 1, 2018.
 Sale on the floor of a recognized stock exchange in India.
 In certain notified listed equity shares, there is a condition that STT should have been paid at the time of acquisition of such shares as well at the time of transfer so as to be eligible for this regime.
Participation of Category III Alternative Investment Funds in the Commodity Derivatives Market
SEBI has by way of its circular dated June 21, 2017, permitted Category III Alternative Investment Funds to participate in the commodities derivatives market subject to the following conditions:
i. to participate on the commodity derivatives exchanges as ‘clients’, subject to compliance of all SEBI rules, regulations, position limit norms issued by SEBI / stock exchanges etc., as applicable to clients;
ii. to not invest more than 10% of the investable funds in one underlying commodity;
iii. leveraging or borrowing subject to consent from the investors and maximum limit specified by SEBI (presently capped at 2 times the net asset value of the fund);
iv. disclosures to be made in the private placement memorandum of intent to invest in commodity derivatives, consent of existing investors to be taken and exit opportunities to be provided to the dissenting investors; and
v. to comply with SEBI reporting requirements.
Proposals approved at SEBI Board Meetings
Some of the key proposals approved in the board meetings of the SEBI held on April 26, 2017 and June 21, 2017 are as follows:
i. Amendment to the SEBI (Stock Brokers and Sub-brokers) Regulations, 1992 to permit stock brokers / clearing members currently dealing in commodity derivatives to deal in other securities and vice versa, without setting up a separate entity;
ii. Relaxations from preferential issue requirements under the ICDR Regulations and from open offer obligations under the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011 (‘SAST Regulations’) which are currently available to lenders undertaking strategic debt restructuring of listed companies in distress, and be extended to new investors acquiring shares in such distressed companies pursuant to such restructuring schemes. Such relaxations, however, will be subject to shareholder approval by way of a special resolution and lock-in of shares for a minimum period of 3 years. The relaxations will also be extended to lenders under other restructuring schemes undertaken in accordance with the guidelines of the RBI;
iii. Exemption from open offer obligations under the SAST Regulations, for acquisitions pursuant to resolution plans approved by the NCLT under the IBC;
iv. Extension of relaxations in relation to the lock-in provisions currently available to Category I AIFs in case of an initial public offering to Category II AIFs as well;
v. Proposal for initiation of a public consultation process to make amendments to the FPI Regulations: (a) expansion of the eligible jurisdictions for the grant of FPI registrations to Category I FPIs by including countries having diplomatic tie-ups with India; (b) simplification of broad based requirements; (c) rationalization of fit and proper criteria; and (d) permitting FPIs operating under the multiple investment managers structure and holding FVCI registration to appoint multiple custodians; and
vi. Levy of a regulatory fee of USD 1,000 on each ODI subscriber, once every 3 years, starting from April 1, 2017 and to prohibit ODIs from being issued against derivatives except those which are used for hedging purposes.
Qualification for Long Term Capital Gains Tax Exemption
Finance Act, 2017 (‘Finance Act’) had amended Section 10(38) of Income Tax Act, 1961 (‘ITA’) to withdraw the long-term capital gains tax exemption available on transfer of listed equity shares acquired on or after October 1, 2004 and which were not chargeable to Securities Transaction Tax (‘STT’). However, the Central Government was authorized to carve out those transactions, which would not lose the capital gains tax exemption, by issuing a notification in that regard.
In pursuance thereof, the Central Board of Direct Taxes (‘CBDT’) has issued a notification dated June 5, 2017 listing both, i.e. the transactions which will lose exemption and also those transactions which will not lose the exemption, as per details below:
i. Acquisition of existing listed equity shares in a company, whose equity shares are not frequently traded in a recognized stock exchange of India, which are made through a preferential issue. However, the following acquisition of listed equity shares (even if made through a preferential issue) are protected and continue to be covered by Section 10(38) exemption:
a. Acquisition of shares which has been approved by the Supreme Court (‘SC’), High Court (‘HC’), NCLT, SEBI or RBI in this behalf;
b. Acquisition of shares by any non-resident in accordance with foreign investment guidelines;
c. Acquisition of shares by an Investment fund or a Venture Capital Fund or a QIB; and
d. Acquisition of shares through a preferential issue to which the provisions of Chapter VII of the ICDR Regulations do not apply.
ii. Transactions for acquisition of existing listed equity shares in a company which are not entered through a recognized stock exchange. However, the following acquisitions of listed equity shares are protected (even if not made through a recognized stock exchange) and continue to be covered by Section 10(38) exemption.
a. Acquisition through an issue of share by a company other than preferential issue, as an example receipt of bonus shares, shares upon conversion of instruments or splitting of shares;
b. Acquisition by scheduled banks, reconstruction or securitization companies or public financial institutions during their ordinary course of business;
c. Acquisition which has been approved by the SC, HCs, NCLT, SEBI or RBI in this behalf;
d. Acquisition under employee stock option scheme or employee stock purchase scheme framed under the SEBI (Employee Stock Option Scheme and Employee Stock Purchase Scheme) Guidelines, 1999;
e. Acquisition of shares by any non-resident in accordance with foreign investment guidelines;
f. Acquisition of shares under SAST Regulations;
g. Acquisition from the Government;
h. Acquisition of shares by an Investment fund or a Venture Capital Fund or a QIB; and
i. Acquisition by mode of transfer referred to in Sections 47 or 50B of the ITA if the previous owner of such shares has not acquired them by any mode which is not eligible for exemption as per this notification.
iii. Acquisition of equity shares of a company during the period of its delisting from a recognized stock exchange.
Changes in the Foreign Investment regime in India
The Reserve Bank of India (‘RBI’) recently issued the Master Directions on Foreign Investment in India (‘Master Directions’) on January 4, 2018, on the heels of the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 (‘New FEMA 20’) issued by way ofNotification dated November 7, 2017, which replace the Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2000 (‘Erstwhile FEMA 20’) and the Foreign Exchange Management (Investments in Firms of Proprietary Concerns in India) Regulations, 2000.
The New FEMA 20 and the Master Directions now contain comprehensive rules on foreign investment in India as issued by the RBI. A summary of some of the key changes to the Erstwhile FEMA 20 introduced by the RBI are set out below:
i. Definition of ‘Capital Instruments’: The New FEMA 20 has introduced a definition of ‘Capital Instruments’. While the base definition remains similar to that of ‘Capital’ under the Erstwhile FEMA 20, two clarifications have been provided as follows:-
(a) Non-convertible/ optionally convertible/ partially convertible preference shares issued up to April 30, 2007, as well as optionally convertible/ partially convertible debentures issued up to June 7, 2007 will be considered to be capital instruments till their original maturity; and
(b) Share warrants can be issued to a person resident outside India only in accordance with the regulations issued by the Securities and Exchange Board of India (i.e. the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009), i.e. share warrants can be issued to a person resident outside India only by a listed Indian company.
ii. Definition of ‘Foreign Investment’: ‘Foreign investment’ has been defined under the New FEMA 20 to mean any investment by a person resident outside India in the capital instruments of an Indian company or in the capital of a limited liability partnership (‘LLP’), on a repatriable basis; thereby clarifying that investments made on a non-repatriable basis are to be treated as domestic investments and not included in the foreign investment limits.
iii. Definition of ‘Foreign Direct Investment’: The definition of ‘foreign direct investment’ (‘FDI’) under the New FEMA 20 distinguishes between investments in unlisted and listed Indian companies. While any investment by a person resident outside India in the capital instruments issued by an unlisted Indian company is to be treated as FDI, in case of listed Indian companies, only investments of 10% or more of the post issue paid-up equity capital of a listed Indian company, computed on a fully diluted basis, is to be treated as FDI.
iv. New Concept – Foreign Portfolio Investment: Under New FEMA 20, RBI has introduced a new concept of an investment being categorized as ‘Foreign Portfolio Investment’ if the investment made by a person resident outside India in a listed Indian company is less than 10% of the post issue paid-up equity share capital (on a fully diluted basis) of such listed Indian company or less than 10% of the paid up value of each series of capital instruments of such listed Indian company. Please note that there a distinction between foreign portfolio investment and investment by an entity registered with SEBI as a foreign portfolio investor (‘FPI’). All investments by each FPI will necessarily be foreign portfolio investment, whereas investment by entities who are not registered as FPI can also be categorized as ‘foreign portfolio investment’ depending upon the percentage of investment made. Purchase / sale of capital instruments of listed Indian company on a stock exchange by FPIs is set out in Schedule 2 of the New FEMA 20.
Foreign portfolio investment by way of a primary subscription is exempt from the reporting requirements prescribed in respect of FDI transactions. In the event foreign portfolio investment exceeds the 10% limit, such investment will stand re-classified as FDI. However, on the other hand, in the event an existing investment by a non resident in a listed Indian company falls to a level below 10% of such company’s post issue paid up equity capital (on a fully diluted basis), such investment will continue to be treated as FDI.
v. Definition of ‘Indian entity’: The tern Indian entity has been defined to mean an Indian company and an LLP.
vi. Definition of ‘Investment Vehicle’: The Master Directions clarify that venture capital funds established in the form of a trust, company or a body corporate and registered under the SEBI (Venture Capital Funds) Regulations, 1996 will not be considered as investment vehicles for the purposes of the New FEMA 20. Prior Government approval would be required for making foreign investments in venture capital funds established as trusts.
vii. Definition of ‘Listed Indian Company’: Listed Indian Company has been defined to mean an Indian company which has any of its capital instruments listed on a recognized stock exchange in India. Accordingly, an Indian company which has only its non-convertible debentures listed on a stock exchange would not be considered as a Listed Indian Company.
viii. Acquisition through a rights or bonus issue: While the conditions relating to acquisition of capital instruments (other than warrants) by way of rights or bonus issue continue to remain the same, it have been clarified that the conditions would also apply to subscription to capital instruments issued as a rights issue that are renounced by the person(s) to whom they were offered.
Further, a person resident outside India exercising any rights in respect of capital instruments issued when he / she was resident in India, can exercise such rights on a non-repatriation basis (i.e. the original status of the holding will not change even in the event the residential status of the holder changes).
Similarly, an individual resident outside India exercising an option granted pursuant to an employee stock option scheme when he / she was resident in India, can hold the shares so acquired on exercising the option on a non-repatriation basis.
ix. Transfer of capital instruments: Transfer by way of sale of capital instruments by a non-resident Indian (‘NRI’) to non-residents other than NRIs no longer requires prior RBI approval, subject to certain conditions.
x. Reporting Requirements: The onus of filing Form FC-TRS for transfers on a recognized stock exchange will now vest with the non-resident party and not the relevant Indian company. The New FEMA 20 has further clarified that in case of transfer of repatriable capital instruments by a non-resident transferor to another non-resident transferee on non-repatriable basis, the onus of such filing would vest with resident transferor / transferee or the non-resident holding capital instruments on a non-repatriable basis, as the case may be. It is also clarified that a transfer of capital instruments between a non- resident transferor holding such instruments on non-repatriable basis and a resident transferee would not attract such a reporting requirement.
Further, Form FC-TRS is now required to be filed with the authorised dealer bank with 60 days of transfer of capital instruments or receipt / remittance of funds, whichever is earlier.
xi. Downstream investments: While the definition of ‘downstream investments’ under the Erstwhile FEMA 20 only considered indirect foreign investments by one Indian company into another Indian company, the definition has now been revised to include investments by Indian companies, LLPs or investment vehicles (each, an Indian entity), in the capital instruments or the capital (as the case may be), of another Indian company or LLP. Further, downstream investments are now required to be reported by way of a Form DI within 30 days of such investment to the Secretariat for Industrial Assistance, Department of Industrial Promotion. However, the format of this Form DI is yet to be specified by the RBI.
xii. Clarifications regarding reporting and pricing guidelines: In addition to the above, the New FEMA 20 has further clarified that capital instruments of any Indian company held by another Indian company which is not owned and not controlled by resident Indians or is owned and controlled by persons resident outside India (‘FOCC’), can be transferred to:
(a) a person resident outside India without any requirement to adhere to pricing guidelines, provided however such transfer is reported by way of Form FC-TRS;
(b) a person resident in India, subject to adherence with pricing guidelines only; and
(c) another FOCC, without any requirement to adhere to pricing guidelines or to the reporting requirements.
xiii. Rate of dividend on preference shares: Under the New FEMA 20, the ceiling limit of 300 basis points over the prime lending rate of State Bank of India on the rate of dividend on preference shares or convertible preference shares issued under the said regulations has been done away with.
xiv. Alignment with the provisions of Companies Act, 2013: In addition to the above, the New FEMA 20 has attempted to align several provisions with those of the Companies Act, 2013, in order to address ambiguities that existed under the Erstwhile FEMA 20. A few of such alignments include:
(a) the definitions of ‘employees’ stock option’ and ‘sweat equity shares’ have been aligned with the corresponding definitions under the Companies Act, 2013; and
(b) timeframe for allotment of capital instruments has been reduced from 180 days to 60 days.
xv. Late submission fee for delayed filings: The New FEMA 20 states that delay in complying with reporting requirements (including Forms FC-GPR and FC-TRS) will now attract late submission fee (‘LSF’) of such amount as may be determined by the RBI in consultation with the Central Government. Paragraph 12 of Part IV of the Master Direction on Reporting under Foreign Exchange Management Act, 1999 provides for the quantum of LSF for regularizing reporting delays without undergoing the compounding procedure as under:
Amount involved in reporting
LSF as a % of amount involved*
Maximum amount of LSF applicable
Up to 10 million
Rs.1 million or 300% of amount involved, whichever is lower.
More than 10 million
Rs.10 million or 300% of amount involved, whichever is lower.
* The LSF would be doubled every 12 months.
The LSF shall be applicable for the transactions undertaken on or after November 7, 2017.
xvi. New forms to be filed:
(a) A Indian company issuing employee stock option to, inter-alia, persons resident outside India who are its employees / directors, is required to submit Form –ESOP within 30 days of such issuance.
(b) An LLP receiving amount of consideration for capital consideration and acquisition of profits shall submit Form LLP (I) within 30 days of receipt of amount of consideration.
(c) The divestment of capital contribution between a resident and non-resident in case of an LLP shall be reported in Form LLP (II) to the authorised dealer within 60 days from the date of receipt of funds.
(d) An Indian start-up company issuing Convertible Notes to a person resident outside India shall report such inflows to authorised dealer bank in Form CN within 30 days of such issue.
 Regulation 2(v) of New FEMA 20 read with Paragraph 2.2 of the Master Directions.
 Regulation 2(xviii) of New FEMA 20 read with Paragraph 2.9 of the Master Directions.
 Regulation 2(xvii) of New FEMA 20 read with Paragraph 2.6 of the Master Directions.
 Regulation 2(ix) of New FEMA 20 read with Paragraph 2.7 of the Master Directions.
 Regulation 2(xxv) of New FEMA 20 read with Paragraph 2.11 of the Master Directions.
 Paragraph 2.14 of the Master Directions.
 Regulation 2(xxxi) of New FEMA 20 read with Paragraph 2.16 of the Master Directions.
 Explanation to Regulation 6 of New FEMA 20 read with Paragraph 6.11.4 of the Master Directions.
 Proviso to Regulation 6 of New FEMA 20 read with Paragraph 6.11.2 of the Master Directions.
 Proviso to Regulation 7 of New FEMA 20 read with Paragraph 6.12.2 of the Master Directions.
 Regulation 13.1(4)(b) of New FEMA 20.
 Regulation 13.1(4) of New FEMA 20.
 Regulation 13.1(4) of New FEMA 20.
 Regulation 4 of New FEMA 20 read with Paragraph 9 of the Master Directions.
 Regulation 13.1(11) of New FEMA 20.
 Regulation 14(5)(c) of New FEMA 20 read with Paragraph 9.6 of the Master Directions.
 Regulation 13.1(5) of New FEMA 20.
 Regulation 13.1(7) of New FEMA 20.
 Regulation 13.1(8) of New FEMA 20.
 Regulation 13.1(12) of New FEMA 20.
Changes in Investment in Debt Securities by Foreign Portfolio Investors
The Reserve Bank of India (‘RBI’) recently issued a notification dated June 15, 2018, in supersession of the RBI notifications dated April 27, 2018 and May 1, 2018, for providing some operational flexibility as well as transition path for investments by Foreign Portfolio Investors (‘FPIs’) in debt (‘Notification’). Below is a summary of the key changes brought about by this notification:
i. Reduced minimum residual maturity for corporate bonds: The minimum residual maturity requirement for investments by FPIs in corporate bonds has reduced from three years to one year (subject to the condition that short-term investments in corporate bonds by a FPI, calculated on an end-of-day basis, must not exceed 20% of the total investment of that FPI in corporate bonds). Investments: (a) made in security receipts issued by asset reconstruction companies (‘SRs’); or (b) made on or before April 27, 2018, must not be included to calculate such limit.
ii. Single/ Group investor wise concentration limits: This notification imposes the following investor and group wise limits for investments in corporate bonds:
· Per ‘issue’ limit: FPIs can invest in any issue of corporate bonds subject to a cap of 50% of such issue. If such limit is already breached by investments made by an FPI and/or its investor group, such FPIs may not make further investments in such issue until such limit is met. This requirement is not applicable in respect of investments by FPIs in SRs.
· Per ‘corporate’ limit: As on April 27, 2018, FPIs cannot have an exposure of more than 20% of its entire corporate bond portfolio to a single corporate (this includes exposures to related entities of the corporate). If the exposure exceeds 20%, the FPI cannot make further investments in that corporate / group until the above concentration limit is met. Investments in new corporate bonds made by the FPI after April 27, 2018 (in corporates other than those referred to in para a) above) will have to meet the 20% corporate limit from April 1, 2019 onwards. FPIs registering after April 27, 2018 are permitted to comply with this requirement by: (a) March 31, 2019; or (b) six months from the date of registration, whichever is later. The restrictions mentioned above in respect of corporate bonds are not applicable to investments by multilateral financial institutions and to investments by FPIs in SRs.
iii. Relaxation of norms for pipeline investments: Investment transactions by FPIs in corporate bonds that were under process but had not materialised as on April 27, 2018 (pipeline investments), will be exempt from the ‘per issue’ limit and ‘per corporate’ limits described above, subject to the custodian of the FPI reasonably satisfying itself that: (a) the major parameters such as price/rate, tenor and amount of the investment have been agreed upon between the FPI and the issuer on or before April 27, 2018; (b) the actual investment will commence by December 31, 2018; and (c) the investment is in conformity with the extant regulations governing FPI investments in corporate bonds prior to April 27, 2018.
iv. Concentration limits per category of FPI: The following limits for the relevant category, inter alia, have been prescribed by this notification for investments by FPIs in Central Government securities (‘G-secs’), State Department Loans (‘SDLs’) and corporate debt securities: (i) 15% of the prevailing limit; and (ii) 10% of the prevailing limit.
v. Minimum residual maturity for G-secs: The Notification permits FPIs to invest in G-secs (including in treasury bills and SDLs) without any minimum residual maturity requirement, provided that investments by a FPI in securities with residual maturity less than one year, will not exceed 20% of the total investment of that FPI in that category.
vi. The cap on aggregate FPI investments in Central G-secs has been increased from 20% to 30% of the outstanding stock of that security.
vii. FPIs have been prohibited from investing in partly paid instruments.
 Investments with residual maturity up to one year.
Guidelines for Preferential Issue of Units by InvITs
SEBI issued a circular dated June 5, 2018 (‘Circular’) setting out guidelines for preferential issue of units by InvITs.As per the Circular, listed InvITs may make a preferential issue of units to an institutional investor subject to the fulfillment of the following conditions:
i. Conditions for preferential issue: (a) Unitholders of the InvIT have to pass a resolution approving the preferential issue; (b) InvIT must be in compliance with the minimum public unitholding requirements, conditions for continuous listing and disclosure obligations; (c) No preferential issue of units by the InvIT should have been made in the six months preceding the relevant date and the issue will be completed within 12 months of the authorizing resolution; (d) The preferential issue of units can be offered to a minimum of two and maximum of 1000 investors in a financial year.
ii. Placement document: The preferential issue of units by an InvIT will be done on the basis of a placement document, which must contain disclosures as specified in the Circular. While seeking in-principle approval from the recognised stock exchange, InvIts to furnish a copy of the placement document, a certificate issued by its merchant banker or statutory auditor confirming compliance with the provisions of this Circular along with any other documents required by the stock exchange
iii. Pricing: The preferential issue is required to be made at a price not less than the average of the weekly high and low of the closing prices of the units quoted on the stock exchange during the two weeks preceding the relevant date. The InvIT cannot allot partly paid-up units. Further, the prices determined for preferential issue will be subject to appropriate adjustments, if the InvIT: (i) makes a right issue of units; and (ii) is involved in such other similar events or circumstances, which in the opinion of the concerned stock exchange, requires adjustments.
iv. Restriction on allotment: No allotment can be made to any party to the InvIT or their related parties except to the sponsor.
v. Restriction on transferability: The units allotted under preferential issue cannot be sold by the allotee for a period of one year from the date of allotment, except on a recognized stock exchange.
Guidelines for Issuance of Debt Securities by REITs and INVITs
SEBI had recently permitted Real Estate Investment Trusts (‘REITs’) and Infrastructure Investment Trusts (‘InvITs’) to issue debt securities by amending the SEBI (REIT) Regulations, 2014 (‘REIT Regulations’) and the SEBI (INVIT) Regulations, 2014 (‘InvIT Regulations’). SEBI has issued guidelines for issuance of such debt securities by REITs and InvITs by its circular dated April 13, 2018 (‘Circular’) which provides that REITs and InvITs issuing debt securities must follow the provisions of SEBI (Issue and Listing of Debt Securities Regulations), 2008 (‘ILDS Regulations’) in the following manner:
i. Restriction in Regulation 4(5) of the ILDS Regulations on issue of debt securities for providing loan to or acquisition of shares of any person, who is party of the same group or under the same management and the requirement for creation of a debenture redemption reserve, will not apply to issue of debt securities by REITs and InvITs;
ii. Compliances to be made under Companies Act in terms of the ILDS Regulations, will not apply to REITs / InvITs for issuance of debt securities, unless specifically provided in the Circular.
For the issuance of debt securities, REITs / InvITs will appoint one or more SEBI registered debenture trustees, other than the trustee to the REIT / InvIT issuing such debt securities. Further, the securities will be secured by the creation of a charge on the assets of the REIT / InvIT or holding company or SPV, having a value which is sufficient for the repayment of the amount of such debt securities and interest thereon. The Circular also provided for certain additional disclosure and compliance requirements.
Exemption to Interest Income on Specified Offshore Rupee Denominated Bonds
The ITA currently provides for a tax rate of 5% (plus applicable surcharge and cess) for interest payable with respect to moneys borrowed by an Indian company / REIT / InVT from a source outside India by way of the issuance of Rupee denominated bonds (at any time till June 30, 2020) subject to compliance with prescribed conditions and interest ceiling. These borrowings have now been further incentivized to augment the foreign exchange inflow in the country. Pursuant to a press release dated September 17, 2018, tax exemption has been announced for interest payable by an Indian company / REIT / InVT to a non-resident / foreign company in respect of Rupee denominated bonds issued outside India during September 17, 2018 to March 31, 2019. No tax will be deducted on the payment of interest on such bonds. The press release further states that legislative amendments in this regard will be proposed in due course.
Fund-raising in India – challenges faced by Indian Fund Managers
An emerging market such as India, with its growing appetite for development, has an ever-increasing requirement for capital and a sound regulatory framework is key in enabling innovative financial instruments through which money can be channelled to India.
With the aid of the Indian regulators, new asset classes, in particular alternative investment funds (AIFs) have grown in the Indian market. Indian Private Equity Report, 2017, issued by Bain and Company highlights that registered AIFs in India have more than doubled over the past 2 years and stood at approximately 270 in 2016. AIFs have also been a significant contributor to overall fund-raising in the Indian market and contributed to 41% of the total India-focussed funds raised in 2016, compared with only 11% in 2014.
The brisk growth of AIFs in India raises an important question – where are Indian fund managers raising this capital from and what is the participation of Indian investors in these pooling vehicles?
The Alternative Investment Policy Advisory Committee (AIPAC) Report, 2016 states that in India, a mere 10-15% of equity capital required by start-ups, medium enterprises and large companies is funded from domestic sources. The remaining 85% – 90% is sourced from overseas. This is in contrast to the U.S. and China where domestic sources fund 90% and 50% respectively, of the venture capital and private equity needs of enterprises. Prequin report of November 2017 on Alternative Assets in India states that a significant proportion (approximately 40%) of India-based institutional investors do not invest in alternatives, reiterating the relative unfamiliarity of the alternatives market for investors in India. However, the report observes that as these institutions develop and mature, the proportion may shrink, as the demand for alternative investments to maximize portfolio diversification increases, as does their familiarity with the alternatives market.
Given the growing awareness amongst Indian institutions to participate in AIFs in particular, this article provides a snapshot of the key legal and regulatory aspects that Indian fund managers need to be cognizant of, while approaching and raising capital from: banks, insurance companies (life and non-life) and pension funds.
Challenges for each institution
The Reserve Bank of India (RBI) has permitted scheduled commercial banks (excluding regional rural banks and urban co-operative banks) in India to invest in category I and category II AIFs, albeit with certain conditions. Banks are permitted to invest not more than 10% of the paid-up capital/unit capital in a category I/category II AIF and if investment exceeds 10% of the paid-up capital/unit capital in a category I/category II AIF, the bank would require prior approval from the RBI. The regulatory maximum for investments in AIFs (category I and category II) has been capped at 20% of the bank’s net worth permitted for direct investments in shares, convertible bonds/debentures, units of equity oriented mutual funds and exposures to AIFs. Investments by banks in category III AIFs continues to be not permitted. Further, the requirement imposed on banks to maintain additional capital basis a risk assessment on account of investments in AIFs made either directly or through their subsidiaries is an added restriction imposed on banks in making investments in AIFs.
Overall, while a banks’ participation in AIFs has been restricted, it still has opened up a significant source of capital raise domestically. The need of the hour is to permit banks to invest in category III AIFs as well (albeit within limits) which will provide a capital source to such AIFs which are today heavily reliant on foreign capital and Indian retail fund raise.
With respect to insurance companies, Insurance Regulatory and Development Authority (IRDA) has permitted both general insurance and life insurance companies to invest in category I AIFs such as infrastructure funds, small and medium enterprise (SME) funds, venture capital funds and social venture funds (as defined under the SEBI (AIF) Regulations, 2012) and category II AIFs (which will invest at least 51% of the funds in infrastructure, SME, venture capital and/or social venture entities). The permission to invest in AIFs from IRDA however, comes with certain additional restrictions. For one, insurance companies are not permitted to invest in AIFs which seek to invest in securities of companies incorporated outside India, will take leverage and/or will be classified as fund of funds. In addition, any investment by the insurance company in AIFs is categorised as an ‘unapproved investment’ and requires approval of the board of directors in addition to the approval of the investment committee of the insurance company. Further, overall exposure to AIFs is capped at 3% of respective fund in case of life insurance companies and 5% of investment assets in case of general insurance companies. Vis-à-vis a single AIF, insurance companies (both life and general) are permitted to invest the lower of 10% of the AIF fund size and 20% of the overall exposure permitted, provided that in case of infrastructure funds, the limit is to be read as 20% of the AIF fund size. Further, insurance companies cannot invest in an AIF, the sponsor of which is a part of the promoter group of the insurer and/or the investment manager is either directly or indirectly controlled or managed by the insurer or its promoters. In light of the growing awareness and interest of insurance companies to invest in AIFs, further liberalisation of the investment conditions such as permission to invest in category III AIFs (which do not undertake leverage), AIFs which are fund of funds and AIFs which can invest in companies incorporated outside India, subject to compliance with SEBI prescribed conditions, would go a long way in mobilising funds from insurance companies in the AIF industry.
Pension Fund Regulatory and Development Authority (PFRDA) has recently permitted private sector national pension system scheme (NPS) subscribers to invest in category I and category II AIFs albeit with the condition that such category of investment has to be in listed instruments or fresh issues that are proposed to be listed. Given the lack of a definitive listing regime for AIFs, this peculiar condition has created a challenge for pension funds to invest in AIFs. Further, the guidelines prescribe that such NPS should invest into units of AIF which have minimum AA equivalent rating in the applicable rating scale from one credit rating agency registered with SEBI, albeit such credit rating would not be required in case of a government owned AIF. Other conditions prescribed by PFRDA are similar to the conditions imposed by IRDA in respect of investment into AIFs by insurance companies, such as the 51% fund utilisation conditions for category II AIFs, exposure of 10% of the AIF size in a single AIF, restriction in respect of AIFs who would invest in companies incorporated outside India and the group sponsor and manager restrictions. In addition, the guidelines prescribe that pension funds should only invest in such AIFs whose corpus is equal to or more than INR 100 crores. Whilst the guidelines permitting investment by pension funds into AIFs has been a step in the right direction, much is left to be desired. Restrictions such as minimum corpus of AIF being an eligibility criterion for pension fund investment, credit rating for AIF units and requirement to only invest in listed AIFs, create a considerable road block for investment by NPS in AIFs.
Insurance companies and pension funds have long-term liabilities and given the time gap between the receipt of premium/investment and the payment of claims and returns, they have substantial pool of capital which can be deployed in long-term assets. While this fact has been recognised in foreign jurisdictions where insurance and pension funds are permitted to deploy capital in AIFs in India, the restrictions on insurance and pension companies in India have limited their participation in AIFs. As a first step, pension funds can be brought at par with insurance companies. This will ensure that we see increased participation by them in the AIF industry.
Given the restrictions, often onerous, imposed on fund managers accepting domestic capital from Indian institutions highlighted above, many fund managers first look to raise offshore capital and domestic capital from private institutions, family offices and high net worth individuals. If any meaningful capital raise is to happen from India, the financial institutions mentioned herein with significant capital at their disposal should be allowed more flexibility to invest in alternative assets, albeit with checks and balances. This will go a long way in giving much needed fillip to the ever growing AIF industry.
1. Pallabi Ghosal, Partner
2. Ananya Sonthaliya, Senior Associate
Key Guidance issued by SEBI on AIF Operative Aspects
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.