The regulator wants a third-party intermediary, governed by rules of the capital market, to verify information in a fund’s ‘private placement memorandum.’ PPM is the key document prospective investors skim through before putting money in alternative investment funds (AIFs) – the regulatory term for PE and VC funds.
The stand taken by Sebi follows large funds, running multiple schemes with thousands of crores of assets under management (AUM), submitting PPMs that are incomplete and often in violation of regulations.
The issue was discussed and the lapses in applications by several AIFs were shared by Sebi officials this month with the Alternative Investment Policy Advisory Committee, headed by NR Narayana Murthy, two persons aware of the development told ET.
“For instance, one of the PPMs by a large fund said it would make temporary investments in instruments issued by entities in OECD countries,” said a person present in the meeting. “Another said it would give loans and guarantees, while (yet) another said it would allow indirect co-investments and extend the tenure of funds with the consent of the advisory committee. None of these are allowed under regulations… These applications did not come from small funds or newbies.”
One of the PPMs talked about giving special rights to a select class of investors to extend the commitment period (during which a fund is allowed to call in capital from investors for making new investments).
There are around 700 AIFs in India with more than Rs 4.5 lakh crore committed by investors.
Sebi thinks that the presence of a merchant banker would help in reducing irregularities in PPM and quicken clearance of applications. But the regulator will have to dispel the fears that AIFs harbour.
“An AIF is far more bespoke a product, and expecting a merchant banker to oversee the fund documents is premised on the fact that they are expected to understand the nuance of the product as well as the fund entity itself, which may not be true,” said Siddharth Shah, senior partner at law firm & Co. “Second, involving an intermediary will add to the cost of fundraising, which is already high in India compared to many other markets, besides adding to the complexity of the process. Lastly, forcing an involvement of a merchant banker and making them powerful could hamper product innovation as the intermediaries start dictating product offerings.”
While AIFs should not lose their flexibility, Sebi, said a person aware of the discussions, is firm that there has to be a set of minimum set of disclosures for investors. “It was pointed out that in some applications, the illustration of the ‘waterfall’ was missing. One of the PPMs did not make disclosures on ‘related party’ and ‘warehousing’ transactions,” said the person.
A ‘waterfall’ lays down how the fund would distribute capital to various investors as it books profits by selling underlying investments. “Many of the violations were by large funds – such as 74 schemes and AUM of Rs 20,000 crore, 20 schemes managing Rs 14,000 crore, four schemes with Rs 7,000 crore, etc,” he said.
Sebi’s recent move is unrelated to previous measures such as introducing a standardised PPM template and mandatory performance benchmarking by AIFs. According to Sebi officials, it is aimed at faster turnaround of approvals, said the person. Sebi is understood to be receiving 20-25 applications for fundraising from AIFs every month.