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Introduction
The Securities and Exchange Board of India (SEBI) has recently introduced significant amendments to the regulations governing Category I and Category II Alternative Investment Funds (AIFs), with a specific focus on borrowing provisions and the extension of tenure for Large Value Funds (LVFs). These changes are aimed at enhancing the operational flexibility of AIFs while ensuring investor protection. This article delves into the key aspects of the amendments, their implications, and the rationale behind these regulatory shifts.
Borrowing Provisions for Category I and II AIFs
Under the existing regulatory framework, Category I and Category II AIFs were restricted in their ability to borrow funds. They could only borrow to meet day-to-day operational needs or to address short-term liquidity requirements. The maximum period for such borrowings was capped at 30 days, with the stipulation that the borrowing could not exceed 10% of the investable funds and could only be undertaken on up to four occasions in a year.
However, the recent amendments provide additional leeway for AIFs, allowing them to borrow funds specifically to cover shortfalls in the drawdown amount from investors. This provision ensures that AIFs do not miss out on potential investment opportunities due to delays in drawdowns, thereby maintaining the fund’s operational efficiency and investment momentum.
Conditions for Borrowing to Meet Shortfalls
The ability to borrow based on shortfalls in drawdown amounts is subject to stringent conditions to prevent misuse:
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Disclosure Requirements: If an AIF intends to borrow for this purpose, the intent must be clearly disclosed in the Private Placement Memorandum (PPM) of the scheme.
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Emergency Use Only: Such borrowing is permitted only in emergency situations, where the investment opportunity is imminent, and the drawdown amount has not been received despite the best efforts by the manager.
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Borrowing Limits: The amount borrowed cannot exceed the lower of:
- 20% of the proposed investment amount in the investee company,
- 10% of the investable funds of the scheme, or
- The net undrawn capital contribution from investors other than those who failed to provide the drawdown amount.
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Cost Allocation: The cost of borrowing is to be borne solely by the investor(s) who failed to provide the drawdown amount.
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No Differential Drawdown Timelines: The flexibility to borrow funds cannot be used to offer different drawdown timelines to investors.
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Disclosure to Investors: Managers must disclose the details of the borrowed amount, terms of borrowing, and repayment schedule to all investors on a periodic basis, as per the agreement.
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Cooling-off Period: A 30-day cooling-off period is mandatory between two borrowing periods, calculated from the date of repayment of the previous borrowing.
Rationale Behind the Changes
The primary motivation for these amendments is to provide AIFs with the necessary tools to address liquidity gaps that may arise from delayed drawdowns. By allowing temporary borrowing, SEBI ensures that AIFs can seize investment opportunities without being hamstrung by operational delays. Additionally, the defined limits and stringent conditions help mitigate the risks associated with leveraging, thereby safeguarding investor interests.
Extension of Tenure for Large Value Funds (LVFs)
Large Value Funds (LVFs), which cater to accredited investors with a minimum investment of ₹70 crores, have also seen regulatory adjustments, particularly concerning the extension of their tenure.
Existing Regulations for Tenure Extension
Previously, LVFs were allowed to extend their tenure beyond the initial term by up to two years, subject to the approval of two-thirds of the unit holders by the value of their investments. This extension was applicable only to LVFs with clearly defined extension periods in their PPM.
New Amendments
The recent circular from SEBI permits LVFs to extend their tenure by up to five years, provided they secure approval from two-thirds of the unit holders by the value of their investment in the fund. This change offers greater flexibility for LVFs to manage their investment horizons, aligning with the long-term nature of their investment strategies.
Conditions for Tenure Extension
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Realignment of Existing LVFs: LVFs with undisclosed or indefinite extension periods in their PPMs must align their tenure with the new five-year extension limit by November 18, 2024.
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Investor Consent: Any revision in the original tenure requires the consent of all investors in the scheme.
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Compliance Reporting: LVFs must update their revised tenure in the quarterly report submitted on the SEBI Intermediary Portal (SI Portal) for the quarter ending December 31, 2024. An undertaking must also be submitted to SEBI by November 18, 2024, confirming that investor consent has been obtained.
Impact on Existing LVFs
The new tenure extension framework is designed to prevent LVFs from becoming quasi-perpetual funds, where investments could be locked in for uncertain periods. By capping the extension at five years, SEBI ensures that investors have a clear understanding of the investment horizon, thereby enhancing transparency and trust in the fund’s operations.
Conclusion
SEBI’s recent amendments to the regulations governing Category I and II AIFs and Large Value Funds are a strategic move to enhance the operational flexibility of these investment vehicles. By allowing temporary borrowing to meet drawdown shortfalls and extending the tenure of LVFs, SEBI aims to ensure that these funds can operate efficiently while safeguarding investor interests. These in a dynamic investment landscape, these regulatory changes provide AIFs and LVFs with the necessary tools to navigate challenges and capitalize on opportunities, ensuring their continued growth and success.