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Alternative Investment Funds
SEBI (Alternative Investment Funds) Regulations, 2012
• AIF Regulations are applicable to all privately pooled investment vehicles:
• Exemption:– mutual funds,– collective investment schemes, – family trusts, – ESOP Trusts, – employee welfare trusts, – holding companies,– funds managed by securitization companies or asset
reconstruction companies, – other special purpose vehicles not established by fund
managers including securitization trusts or any such pool of funds which is directly regulated by any other regulator in India
Categories of AIFs based on investment philosophy
(a) Venture Capital Funds: These funds will primarily invest in unlisted securities of start ups, emerging or early stage venture capital undertakings mainly involved in new products, new services, technology or intellectual property rights based activities or a new business model.
(b) Hedge Funds: Hedge Funds will employ diverse or complex trading strategies and invests and trades in securities having diverse risks or complex products, including listed and unlisted derivatives.
(c) Private Equity (“PE”) Funds: PE funds will invest primarily in equity or equity linked instruments or partnership interests of investee companies.
(d) Infrastructure Funds: These funds will primarily invest in unlisted securities or partnership interest or listed debt or securitized debt instruments of investee companies or special purpose vehicles engaged in or formed for, the purpose of operating or holding infrastructure projects.
(e) Debt Funds: These funds will primarily make investments in debt or debt securities of listed or unlisted investee companies.
(f) Small and medium enterprises (“SME”) Funds: These funds will invest primarily in unlisted securities of investee companies which are SMEs or securities of those SMEs which are listed or proposed to be listed on a SME exchange or SME segment of an exchange.
(g) Social Venture Funds: These funds will invest primarily in securities or units of social ventures and which satisfy social performance norms laid down by the fund and whose investors may agree to receive restricted or muted returns.
Categories- for registration with SEBI• Category - I• Funds which invest in – start-up or early stage ventures social ventures– SMEs– Infrastructure– other sectors or • areas which the government or regulators consider as socially or
economically desirable and • shall include – Venture Capital Funds, – SME Funds, – Social Venture Funds and – Infrastructure Funds and– such other AIF as may be specified. • Such funds formed as a trust or a company will be construed as a ‘venture
capital company’ or ‘venture capital fund’, as specified under Section 10 (23FB) of the Income Tax Act, 1961.
• Category - II• This is the residual category and is for those
funds which cannot be classified either as Category I or III and which do not undertake leverage or borrowing, other than to meet day to day operational requirements and as permitted under these regulations.
• This category will include PE Funds or Debt Funds for which no specific incentives or concessions are given by the government or any other regulators.
• Category - III • Funds in this category would adopt diverse or
complex trading strategies and may employ leverage (including through investment in listed/ unlisted derivatives).
• This category will include Hedge Funds or funds which trade with a view to make short term returns or such other funds which are open-ended and for which no specific incentives or concessions are given by the government or any other regulators.
• Registration Rules AIFs shall seek registration in one of the
categories mentioned and in case of Category I AIF, in one of the
subcategories thereof. An AIF which has been granted registration
under a particular category cannot change its category subsequent to registration, – except with the approval of SEBI.
PROCEDURE FOR REGISTRATION
apply
See requirements
validity
• Certificate of registration to be valid till the AIF is wound up.
• Board to consider all the requirements laid down in AIF Regulations for the purpose of grant of certificate
• Application in Form A• Accompanied by non-refundable application fee as
specified in Part A• In the manner as in Part B
Change in control
change in control within the meaning of Reg 2 (1) (e) of
SEBI (SAST) Regulations, 2011
control” includes the right to appoint majority of thedirectors or to control the management or policy decisions
in any other case, change in the controlling interest or
change in legal form
controlling interest means an interest, whether direct or indirect, to the extent of more than fifty percent of voting rights or interest
Therefore, the Regulations are very stringent not to allow controlling interest to be exercised unless 50% interest is there
features The fund may raise funds from any investor whether – Indian, – foreign or – non-resident Indians
• by way of issue of units.•Rs. 20 crore•each investor- 1 Crore
minimum corpus
•25 lakhsDirector/employee /Manager of Fund
•1000 investorsNo of Investors
Investors in AIF • Each scheme of AIF shall have minimum corpus of
INR 200 million ; • Minimum investment ticket size from a single
investor is INR 10 million. However, for investors who are employees or directors of AIF / Manager minimum ticket size would be INR 2.50 million;
• Investment into AIF would be only by way of private placement by issue of information memorandum or placement memorandum;
• AIF can launch schemes subject to filing of placement memorandum with SEBI 30 days prior to launch of the scheme; and
• No material alteration to the fund strategy can be made unless consent of at least 2/3 of unit holders by value of their investment is obtained.
Investee company
Therefore, an AIF can invest even in LLP
COMPANY LLP
BODY CORPORATE
SPV
Minimum interest
sponsor/manager
minimum interest-2.5
Rs. 10crore
Rs. 5 crore
For category III-5 %
Listing
not permitted to raise funds through the stock exchange
Listing can be done up to Rs. 1 crore
after final close of the fund or the scheme
Investment• Up to 25% of the investible funds in any one investee
company• close-ended funds with a minimum tenure of 3 years.• Extend up to up to 2 years
Category I & II
•Up to 10% of the investible funds in any one investee company•may be either close-ended or open-ended
Category III
•QIB- under ICDR 2009Status
AIF shall not invest in associates except with the approval of 75% of investors by value of their investment in the Alternative Investment Fund. AIF shall not invest in associates except with the approval of 75% of investors by value of their investment in the Alternative Investment Fund.
P L AC E M E N T M E M O R A N D U M[R EG U L AT I O N 11 ]
Funds to be raised by issue of Information Memorandum/ Placement
IM to contain information, the key being:
Material information about AIF and Manager
Background of key investment team of manager
Tenure of AIF or scheme
Targeted investors
Investment strategy
Risk management tools and parameters employed
Conflict of interest and procedures to identify and address them
Manner of winding up of the Alternative Investment Fund or the scheme
The points so covered in the AIF Regulations are only inclusive in nature. AIFs to share other relevant information as required to help investors take an informed decision.
The procedure contemplated here, is similar to that of public offering of equity shares.
AIFs may launch schemes subject to filing of PM.
PM to be filed with SEBI atleast 30 days before the launch of the scheme along with the fees prescribed in Second Schedule
Scheme Fees is Rs. 1 lakh
Payment of scheme fees not applicable for launch of first scheme
• Existing Funds• Existing VCFs will be permitted to continue and shall
be governed by the VCF Regulations till such fund or scheme managed by the fund is wound up.
• VCFs will not be permitted to raise any fresh funds after notification of these regulations
• Existing funds (falling within the definition of an AIF) not registered with SEBI may continue to operate for 6 months from the date of commencement of the AIF Regulations
INVESTMENT CONDITIONS FOR
16]CATEGORY 1 [REGULATION
Shall invest in VCU or SPV or LLPs or other units of AIFs
May invest in units of Category I AIFs of same sub-category
Shall not borrow funds or engage in any leverage except:
For meeting temporary funding requirements:
Not more than 30 days
Not more than 4 occasions in a year
Not more than 10% of corpus
Therefore, Category I can fund in another fund too
CATEGORY I-SECTORAL CAPS
[REGULATION 16]
shares or equity linked instruments
VCFS Additional conditions for VCFs- same as VCF Regulations
two-thirds/66.67% of the corpus shall be invested in unlisted equity
Not more than 1/3rd of corpus in:
• IPO of VCU
• Debt or dent instrument in which investment already made by way of equity or contribution towards partnership interests
• Preferential allotment of equity shares of listed company- lock in period of 1 year
• Equity shares of a listed financially weak company or sick industrialcompany
• SPV
CONTD….
SMEsInvest atleast 75% of corpus in unlisted securities or partnerships of VCUs or listed or proposed to be listed SMEs
Such funds may enter into an agreement with Merchant Banker to subscribe to unsubscribed portion of issue
Such funds exempt from Regulations 3 and 3A of Securities and Exchange Board of India (Prohibition of Insider Trading) Regulations, 1992 in case of investment in companies listed on SME exchange subject to conditions prescribed.
CONTD….
muted
their
Social Venture Funds
Atleast 75% of corpus in
unlisted securities or partnership interest of
social ventures
May accept grants,
subject to limit
provided above
May give grants to
social ventures, subject to disclosure
in IM
May accept
returns for
investors
Infra fundCONTD….
Atleast75% ofcorpus
in
partnership interest of venture
• involved in operating, developing
may alsoinvest in
securities of investee companies
• involved in operating, developing
CATEGORY II-SECTORAL CAPS
[REGULATION 17]
borrow funds,
any leverage
with Merchant Banker to
portion of issue
Exempt from Regulations 3 and 3A from Insider Trading
Regulations in case of investment in companies listed on SME exchange
subject to conditions prescribed.
May engage in hedging, subject to guidelines
specified by SEBI
May enter into an agreement
subscribe to unsubscribed
Shall not
or engage in
except-For meeting temporary fund requirements For not more than 30 days, not more than4 occasions in a year, not more than10% of the corpus
Invest primarily in unlisted investee companies or in
units of other AIFs
May invest in Category I or IIAIFs
Barred from investing in units of other FoFs
CATEGORY III-SECTORAL CAPS
[REGULATION 18]
May invest in securities of listed or unlisted investee companies or derivatives or complex or structured products
May invest in units of Category I or II AIFs
Barred from investing in units of other FoFs
May engage in leverage or borrow subject to consent from the investors in the fund and subject to a maximum limit, as specified by SEBI.
Such funds to make disclosures as specified
To be regulated through issuance of directions on operational standards, conduct of business rules, prudential requirements,
restrictions on redemption and conflict of interest as may be specified by SEBI.
VENTURE CAPITAL
MeaningVenture capital means funds made available
for startup firms and small businesses with exceptional growth potential.
Venture capital is money provided by professionals who alongside management invest in young, rapidly growing companies that have the potential to develop into significant economic contributors.
Venture Capitalists generally:
• Finance new and rapidly growing companies
• Purchase equity securities
• Assist in the development of new products or services
• Add value to the company through active participation.
The SEBI has defined Venture Capital Fund in its Regulation 1996 as ‘a fund established in the form of a company or trust which raises money through loans, donations, issue of securities or units as the case may be and makes or proposes to make investments in accordance with the regulations’.
Now Repealed by AIF Regulations 2012
Advantages• It injects long term equity finance which provides a solid capital base
for future growth.• The venture capitalist is a business partner, sharing both the risks
and rewards. Venture capitalists are rewarded by business success and the capital gain.
• The venture capitalist is able to provide practical advice and assistance to the company based on past experience with other companies which were in similar situations.
The venture capitalist also has a network of contacts in many areas that can add value to the company.
The venture capitalist may be capable of providing additional rounds of funding should it be required to finance growth.
Venture capitalists are experienced in the process of preparing a company for an initial public offering (IPO) of its shares onto the stock exchanges or overseas stock exchange such as NASDAQ.They can also facilitate a trade sale.
Stages of financing
1. Seed Money: Low level financing needed to prove a new idea.2. Start-up: Early stage firms that need funding for expenses
associated with marketing and product development. 3. First-Round: Early sales and manufacturing funds. 4. Second-Round: Working capital for early stage companies that are selling
product, but not yet turning a profit .
5. Third-Round: Also called Mezzanine financing, this is
expansion money for a newly profitable company
6. Fourth-Round: Also called bridge financing, it is intended to
finance the "going public" process
• The concept of venture capital was formally introduced in India in 1987 by IDBI.
• The government levied a 5 per cent cess on all know-how import payments to create the venture fund.
• ICICI started VC activity in the same year
• Later on ICICI floated a separate VC company - TDICI
Venture capital funds in India
VCFs in India can be categorized into following five groups:
1) Those promoted by the Central Government controlled development finance institutions. For example:
- ICICI Venture Funds Ltd. - IFCI Venture Capital Funds Ltd (IVCF) - SIDBI Venture Capital Ltd (SVCL)
2) Those promoted by State Government controlled development finance institutions.For example:
- Punjab Infotech Venture Fund - Gujarat Venture Finance Ltd (GVFL) - Kerala Venture Capital Fund Pvt Ltd.
3) Those promoted by public banks.For example:
- Canbank Venture Capital Fund - SBI Capital Market Ltd
4)Those promoted by private sectorcompanies.For example:
- IL&FS Trust Company Ltd - Infinity Venture India Fund
5)Those established as an overseas venture capital fund.For example:
- Walden International Investment Group - HSBC Private Equity
management Mauritius Ltd
Rules & regulations of VC in India
AS PER SEBIAS PER INCOME TAX ACT,1961
As per provision of income-tax rules: The Income Tax Act provides tax exemptions
to the VCFs under Section 10(23FA) subject to compliance with Income Tax Rules.
Restrict the investment by VCFs only in the equity of unlisted companies.
VCFs are required to hold investment for a minimum period of 3 years.
Contd… The Income Tax Rule until now provided that VCF
shall invest only upto 40% of the paid-up capital of VCU and also not beyond 20% of the corpus of the VCF.
After amendment VCF shall invest only upto 25% of the corpus of the venture capital fund in a single company.
There are sectoral restrictions under the Income Tax Guidelines which provide that a VCF can make investment only in specified companies.
Indian Venture Capital and Private Equity Association (IVCA)
It was established in 1993 and is based in Delhi, the capital of India
It is a member based national organization that - represents venture capital and private equity
firms - promotes the industry within India and
throughout the world - encourages investment in high growth companies
and - supports entrepreneurial activity and innovation.
• IVCA members comprise venture capital firms, institutional investors, banks, incubators, angel groups, corporate advisors, accountants, lawyers, government bodies, academic institutions and other service providers to the venture capital and private equity industry.
• Members represent most of the active venture capital and private equity firms in India. These firms provide capital for seed ventures, early stage companies and later stage expansion.
Top cities attracting venture capital investments
CITIES SECTORS
MUMBAI Software services, BPO, Media, Computer graphics, Animations, Finance & Banking
BANGALORE All IP led companies, IT & ITES, Bio-technology
DELHI Software services, ITES , Telecom
CHENNAI IT , Telecom
HYDERABAD IT & ITES, Pharmaceuticals
PUNE Bio-technology, IT , BPO
HEDGE FUND
Introduction
• Alfred Winslow Jones-1940s.• absolute return strategy
• They make extensive use of short-selling—selling a security they do not own in the expectation that its price will fall—and derivatives.
• Most such funds are open-ended • Hedge funds are sometimes called as ‘rich man’s mutual
fund’.
Strategies• There are four broad groups of hedge fund
strategies: arbitrage, event-driven, equity-related and macro– The first two groups in many cases
attempt to achieve returns that are uncorrelated with general market movements, where managers try to find price discrepancies between related securities, using derivatives and active trading based on computer driven models and extensive research
– The second two groups are impacted by movements in the market, and they require intelligent anticipation of price changes in stocks, bonds, foreign exchange and physical commodities
Hedge Fund Strategies Can be Grouped into Four Major Categories
Source: McKinsey Global Institute; Hedge Fund Research, Inc.; David Stowell
Subcategory DescriptionAr
bitr
age
Fixed-income based arbitrage
Exploits pricing inefficiencies in fixed-income markets, combining long/short positions of various fixed income securities
Convertible arbitrage
Purchases convertible bonds and hedges equity risk by selling short the underlying common stock
Relative value arbitrage
Exploits pricing inefficiencies across asset classes-e.g., pairs trading, dividend arbitrage, yield curve trades
Even
t Dr
iven
Distressed securities
Invests in companies in a distressed situation (e.g. bankruptcies, restructuring), and/or shorts companies expected to experience distress
Merger arbitrage Generates returns by going long on the target and shorting the stock of the acquiring company
Activism Seeks to obtain representation in companies' board of directors in order to shape company policy and strategic direction
Equi
ty
Base
d Equity long/short Consists of a core holding of particular equity securities, hedged with short sales of stocks to minimize overall market exposure
Equity non-hedge Commonly known as "stock picking"; invests long in particular equity securities
Mac
ro
Global Macro Leveraged bets on anticipated price movements of stock markets, interest rates, foreign exchange, and physical commodities
Emerging markets Invests a major share of portfolio in securities of companies or the sovereign debt of developing or "emerging" countries; investments are primarily long
• In India, hedge funds can register under category III of AIFs with SEBI.
• So far there are 15 such funds registered with SEBI.
• Hedging and leverage are two key tools used by hedge fund managers to generate positive absolute returns but as per SEBI upto a limit.