In terms of the Regulation 20(20) of the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 (AIF Regulations), every Alternative Investment Fund (AIF), manager of the AIF, and Key Management Personnel (KMP) of the manager and the AIF, is required to undertake specific due diligence with respect to investors and investments of the AIF, to prevent circumvention of laws as specified by SEBI.

 

Accordingly, through its circular dated October 08, 2024 (Circular), Securities and Exchange Board of India (SEBI) has mandated this due diligence to be conducted as per the implementation standards formulated by Standard Setting Forum for AIFs (SFA).  A due diligence framework has been prescribed to prevent circumvention of the following laws:

 

  • investors availing benefits designated for Qualified Institutional Buyers (QIBs) through AIFs under the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018 (ICDR Regulations);
  • investors availing benefits designated for Qualified Buyers (QBs) through AIFs under the Securitisation and Reconstruction of Financial Assets and Enforcement of Security Interest Act, 2002 (SARFAESI Act);
  • RBI regulated entities / lenders evergreening their stressed loans through AIFs; and
  • Investments from land bordering countries (LBCs) made through AIFs.

 

  • Investors availing benefits under ICDR Regulations and SARFAESI Act

 

Under ICDR Regulations and SARFAESI Act, AIFs are entitled to certain benefits due to their designation as qualified institutional buyers (QIBs) and qualified buyers (QBs), respectively. A due diligence framework has been prescribed so that AIFs are not utilized as a means to facilitate investors who are otherwise ineligible for a QIB / QB status on their own, to avail benefits extended to such QIBs/ QBs through AIFs.

 

As per SFA’s framework, prior to availing any benefits available to QIBs/QBs, every scheme of an AIF would need to ensure that none of its investors and investors belonging to the same group contribute 50% or more to the corpus of the AIF.

 

  • Evergreening of stressed loans by RBI regulated lenders

 

As per SFA’s framework, in order to prevent evergreening of stressed loans, every scheme of an AIF would need to ensure that: (a) the manager or sponsor is not an entity regulated by Reserve Bank of India (RBI); or (b) investor(s) are not regulated by RBI who: (i) individually or along with investors of the same group contribute(s) 25% or more to the corpus of the scheme; or, (ii) is not an associate of the manager/sponsor of the AIF; or, (iii) by itself, or through its representative(s)/nominee(s), does not have majority or veto power in voting over decisions of the investment committee set up by the manager to approve investment decisions of the scheme.

 

Further, the manager of AIF is to ensure that no investments of any scheme leads to an RBI regulated lender/entity to hold or acquire an interest in an investee company indirectly (i.e. through AIF) that they would not be permitted to hold or acquire directly.

 

If the proposed investment fails to meet the SFA’s due diligence requirements as set forth above: (a) the investor or investors from the same group must be excluded from the investment (this exclusion should be necessarily disclosed in the private placement memorandum (PPM)); or (b) the investment should not be made.

 

Additionally, such AIF schemes must also carry the due diligence checks prescribed by the SFA for the existing investments held by the schemes as on the date of this circular i.e. October 8, 2024. If existing investments do not satisfy the due diligence checks for making investments, then details of such investments have to be reported to the custodian of the AIF. If all existing investments satisfy the due diligence checks, then the manager of the AIF has to submit an undertaking to this effect to the custodian. Timeline for submitting both, the report and undertaking is on or before April 07,2025. SEBI has also directed the custodians to compile and furnish this information to SEBI on or before May 07, 2025.

 

  • Foreign Investments from LBCs

 

Under Rule 6 of Foreign Exchange Management (Non-Debt Instruments) Rules, 2019 (NDI Rules), any investor entity from a country which shares land border with India or beneficial owner of an investment into India is situated in or is a citizen of such country, shall only invest with prior government approval. Accordingly, SEBI has specified that necessary due diligence is to be carried as per implementation standards formulated by SFA, prior to making of such investment, if in a scheme of an AIF:

 

As per the SFA framework, any scheme of an AIF is permitted to acquire 10% or more equity or equity linked securities (on a fully diluted basis) in an Indian investee company, provided 50% or more of the corpus is contributed by investors that are:

 

  • not citizens of/situated in/are from LBCs; or
  • whose beneficial owners (as determined in terms of sub-rule (3) of Rule 9 of the Prevention of Money-laundering (Maintenance of Records) Rules, 2005) are not citizens of/situated in/are from LBCs.

 

AIFs in breach of this requirement (including in respect of past investments) are required to report the same to the custodian within 30 days of such investment. Custodian to compile this information, on a monthly basis, and submit the same to SEBI, within 10 working days from the end of the month.

Trustee / sponsor of AIF to ensure that ‘compliance test report’, as prepared by the manager (under Chapter 15 of SEBI’s Master Circular on AIF), includes compliance with the provisions of this Circular.

 

Conclusion: 

 

SEBI This framework is aimed at ensuring that AIFs are conducting thorough due diligence to maintain transparency and compliance with SEBI, RBI and other relevant regulations. Through this Circular, SEBI has tightened oversight on AIF investors and investments.

Authors & Contributors

Partner(s):

Dhruv Chatterjee

 

 

Associate:

Prachi Yadav
Ridima Gupta