Why Does SEBI Want To Change The Way AIFs Operate?

The market regulator is seeking to address a range of issues faced by AIFs to make these structures investment-friendly. From liquidity issues to overcharging of commission by the portfolio managers, the Securities and Exchange Board of India has proposed several changes to how Alternative Investment Funds function.

SEBI’s proposals are likely to benefit AIFs engaged in real estate, tech and healthcare sectors, according to experts.

The challenge stems from the existing AIF regulations that don’t allow for an extension of their tenure for more than two years, even with the approval of the investors. SEBI is also concerned that investors are being overcharged by both the AIF and portfolio managers, who facilitate flows into their structures.

To address the liquidity challenge, SEBI has proposed that AIFs be allowed to carry forward 75% of their unliquidated investments to a new scheme.

The remaining 25% must be liquidated to give an exit opportunity to investors. There are around 24 schemes, with a value of Rs 3,037 crore, which could benefit from this proposal as their life comes to an end in 2024.

Funds in the tech and healthcare sectors are the ones facing liquidity issues, Mayank Mehta, partner at Pioneer Legal, told BQ Prime.

Currently, AIFs whose tenure has come to an expiration can extend for two years, with the approval of two thirds of their investors. No further extension is allowed after that, post which the AIFs are expected to liquidate their investments within one year.

The proposal, while welcome, does cause some concerns around valuation, experts said.

The 75% of investments being carried forward needs to be valued, either basis fresh bids for the part that’s getting liquidated or on the basis of IBBI’s guidelines for the liquidation of assets under the Insolvency Code.

This, however, raises several questions around valuation, according to Parul Jain, co-head of International Tax and Fund Formation at Nishith Desai Associates.

Jain is seeking further clarity on the point.

Vivek Mimani, partner at Khaitan and Co., said that SEBI’s willingness to recognize liquidation vehicle is indeed a welcome move.

Today, AIFs have an option to either sell directly to investors or through registered Portfolio Management Services. This leads to exploitation as the investor is forced to pay not just an AIF’s placement fees but also the additional charges levied for the portfolio management services, SEBI has noted.

To address this, the regulator has proposed direct selling as the only option. This is indeed an investor-friendly suggestion, according to Jain.

SEBI has also proposed to replace upfront commission with trailing commission. The former, it has noted, facilitates misselling as investors are often charged humongous commissions compared to mutual funds.

Trailing commission, where the commission is collected over the years of investment and often based on the performance of the fund, would help in preventing this practice, according to the regulator.

When the commissions in the mutual fund sector are minimal and heavily regulated, commissions for AIFs have fluctuated from 6–9% to 10-15% in the last few years, Mehta said.

To facilitate transparency and increased monitoring of investors, SEBI has proposed for the dematerialisation of AIF units of funds worth over Rs 500 crore in corpus.

This will enable ease of administration and enhance safety of units, according to SEBI.

According to experts, the move is premature as it would only increase the compliance burden of fund managers. This is an unnecessary move as even mutual funds with greater scrutiny are not mandated to dematerialise their units, Mimani said.

That said, it will facilitate proper tracking of all AIF transactions, which are essentially private, and will ensure that no transaction goes untaxed, Mehta highlighted.