Legalaxy - Monthly Newsletter Series - Vol XII - May, 2024

SEBI NOTIFIES THE SEBI (ALTERNATIVE INVESTMENT FUNDS) (SECOND AMENDMENT) REGULATIONS, 2024

Securities Exchange Board of India ("SEBI"), vide its notification dated April 25, 2024, has notified the SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2024 ("AIF Amended Regulations"), thereby amending the SEBI (Alternative Investment Funds) Regulations, 2012 ("AIF Regulations"), with an aim to provide: (a) ease of doing business and flexibility to Category I and II Alternative Investment Funds ("AIFs") to create encumbrance on their equity holdings in investee companies to facilitate raising of debt by such investee companies; and (b) additional flexibility to AIFs and their investors to deal with unliquidated investments of their schemes.

1. Framework for Category I and II AIFs for creating encumbrance on equity holdings in investee companies:
   
   Through the AIF Amended Regulations, provisos to Regulations 16(1)(c) and 17(c) of the AIF Regulations have been inserted. These provisos state that Category I and II AIFs may create encumbrances on the equity of their investee companies, which are engaged in the business of development, operation, or management of projects in any of the infrastructure subsectors listed in the Harmonised Master List of Infrastructure issued by the Central Government. However, the creation of encumbrances is allowed only for the purpose of borrowing by such investee company and subject to such conditions as may be specified by SEBI from time to time.
   
   In this regard, SEBI, vide its circular dated April 26, 2024 ("AIF Encumbrance on Equity Holdings Circular"), has laid down the following framework for creation of encumbrance on equity holdings in investee companies:
   
   
   1. Existing schemes of Category I or II AIFs who have not on-boarded any investors prior to April 25, 2024, are permitted to create such encumbrances as specified above, subject to explicit disclosure in this regard and disclosure of associated risks in their Private Placement Memorandum ("PPM").
   2. Encumbrances created before April 25, 2024 may continue if such encumbrance were created after making an explicit disclosure in the PPM of the scheme. In the event, such encumbrances are created without making an explicit disclosure in the PPM, consent from all investors in the AIF scheme is required to be obtained by October 24, 2024 or else the encumbrances must be removed by January 24, 2025. Further, encumbrances created otherwise than as stated in this AIF Encumbrance on Equity Holdings Circular should be removed latest by October 24, 2024.
   3. Borrowings against encumbered equity must be utilized only for the purpose of development, operation, or management of the investee company, and must not be utilised otherwise, including to invest in another company, and such terms must be incorporated in the investment agreement entered into between the AIFs and the investee company.
   4. The duration of the encumbered equity investments should not exceed the residual tenure of the scheme of the Category I or II AIFs.
   5. Any Category I or II AIFs with more than 50% foreign investment or with foreign sponsor/ manager or with persons other than resident Indian citizens as external members in its investment committee which is set up to approve its decisions must comply with Reserve Bank of India's ("RBI") Master Direction on 'Foreign Investments in India' dated January 4, 2018, as though the AIF is a person resident outside India.
   6. In case of default by the borrower investee company, Category I or II AIFs shall ensure that the fund or its investors are not liable beyond the encumbered equity by the AIF of the investee company.
   7. AIFs are barred from extending any form of guarantee for investee companies.
   8. Category I or II AIFs are prohibited from creating encumbrance on their investments in foreign investee companies.

Managers of AIFs are to adopt and adhere to the implementation standards formulated by the Standard Setting Forum ("SFA"), and the trustee/ sponsor of AIFs, as the case may be, are required to ensure that the 'Compliance Test Report' prepared by the manager in terms of the Master Circular for AIFs dated July 31, 2023 ("Master Circular for AIFs"), includes compliance with the provisions of AIF Encumbrance on Equity Holdings Circular.

2. Enhanced flexibility to AIFs and their investors in managing unliquidated investments:
   
   Regulation 29(9) of the AIF Regulations provides that during the liquidation period of a scheme, AIFs may distribute investments of a scheme which are not sold due to lack of liquidity, in-specie to the investors or enter into the dissolution period, after obtaining approval of at least 75% percent of the investors by value of their investment in the AIF scheme, in the manner and subject to conditions specified by SEBI from time to time. In the absence of consent of unit holders for exercising the options set out above during the liquidation period, such investments of the AIF scheme are to be dealt with in the manner specified by SEBI from time to time.
   
   SEBI, vide its circular dated April 26, 2024 ("AIF Unliquidated Investments Circular"), has now laid down the following conditions in this regard:
   
   
   1. Dissolution period: The AIF Amended Regulations introduces a dissolution period following the expiry of the liquidation period of the scheme, allowing AIFs to liquidate unliquidated investments. Prior to seeking the requisite investor consent, the AIF/manager must arrange a bid for a minimum of 25% of the value of its unliquidated investments. Details pertaining to the proposed tenure of the dissolution period, details of unliquidated investments, value recognition of the unliquidated investments for reporting to performance benchmarking agencies, etc., and an indicative range of bid value, along with the valuation of the unliquidated investments carried out by 2 independent valuers are required to be disclosed to investors prior to seeking their consent. Further, the AIF/manager must intimate SEBI about obtaining the investor consent and the investors' decision to enter into dissolution period, prior to the expiry of the liquidation period. If the AIF scheme fails to sell the unliquidated investments during the dissolution period, such investments shall be mandatorily distributed inspecie to the investors, and no further extension or liquidation period shall be available to these schemes after the expiry of dissolution period.
   2. Mandatory in-specie distribution: During the liquidation period, if AIF fails to obtain requisite investor consent for entering into dissolution period or in-specie distribution, then the unliquidated investments shall be mandatorily distributed to investors inspecie, without the requirement of obtaining consent of 75% of the investors by value of their investment in the AIF scheme. The value of such investments distributed inspecie is recognized at INR 1 for capturing the track record of the manager and for reporting to performance benchmarking agencies.
   3. One-time flexibility for expired liquidation period: Schemes of AIF whose liquidation period has expired or shall expire on or before July 24, 2024 (i.e., within 3 months of notification of the AIF Amended Regulations), shall be granted a fresh liquidation period till April 24, 2025. AIF schemes with pending investor complaints with respect to non-receipt of funds/securities, must resolve them before availing the fresh liquidation period. However, the fresh liquidation period shall be available only from the date of resolution of the complaint till April 24, 2025.
   4. Responsibility for compliance: AIF managers, trustees, and key management personnel are responsible for compliance with the procedure prescribed under AIF Unliquidated Investments Circular. AIF managers must submit compliance reports on the SEBI Intermediary Portal (www.siportal.sebi.gov.in) in the format as specified therein. Further, the AIF trustee/ sponsor, as the case may be, shall ensure that the 'Compliance Test Report' prepared by the manager in terms chapter 15 of the Master Circular for AIFs, includes compliance with the provisions of AIF Unliquidated Investments Circular.
   5. Discontinuation of the option of launching liquidation scheme: Any liquidation scheme launched by an AIF prior to April 25, 2024 (i.e., the date of notification of AIF Amended Regulations) shall continue to be governed by the circular of SEBI dated June 21, 2023 on 'Modalities for launching Liquidation Scheme and for distributing the investments of AIFs in-specie', till such schemes are wound up.

To read the notification click here, to read the AIF Encumbrance on Equity Holdings Circular click here & to read the AIF Unliquidated Investments Circular click here

To read this Newsletter in full, please click here.

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