SEBI Releases New Guidelines for Market Borrowing by Category I and II AIFs

The Securities and Exchange Board of India (SEBI) has introduced a set of new guidelines aimed at regulating the borrowing practices of Category I and II Alternative Investment Funds (AIFs). These guidelines, effective immediately, also detail the conditions under which Large Value Funds for Accredited Investors (LVFs) can extend their tenure. The regulations are part of SEBI's ongoing efforts to ensure transparency and stability in the Indian capital markets, especially concerning the activities of alternative investment funds.

Key Provisions of the Guidelines

Under the new rules, Category I and II AIFs are generally prohibited from borrowing or leveraging funds for investments. However, SEBI has allowed limited exceptions for temporary needs, such as managing day-to-day operational expenses or addressing shortfalls in drawdown amounts from investors. This flexibility is crucial for AIFs, which may occasionally face liquidity challenges that could hinder their investment activities.

SEBI has imposed stringent conditions on such borrowing to ensure it is used judiciously. These AIFs can only borrow for a maximum period of 30 days, and such borrowing is limited to four instances per calendar year. Additionally, the borrowed amount cannot exceed 10% of the fund's investable assets or 20% of the particular investment. Importantly, borrowing is allowed only as a last resort and must be clearly disclosed in the Private Placement Memorandum (PPM) of the fund.

Another critical aspect of the guidelines is the provision that the cost of borrowing will be borne solely by investors who fail to meet their drawdown commitments. This measure ensures that the financial burden of borrowing does not fall on compliant investors, thereby maintaining fairness and transparency within the fund.

Detailed Borrowing Conditions

SEBI's guidelines emphasize that borrowing must not be used to create different drawdown timelines for investors. The details of any borrowing activity, including the amount and repayment status, must be disclosed to all investors on a regular basis. This transparency is intended to keep all stakeholders informed and to prevent any potential misuse of borrowed funds.

The guidelines also stipulate a mandatory waiting period of 30 days between two borrowing periods, calculated from the repayment date of the previous borrowing. This cooling-off period is designed to prevent AIFs from relying excessively on borrowed funds, thereby encouraging better financial discipline.

Extension of Tenure for Large Value Funds

In addition to borrowing guidelines, SEBI has also provided new regulations for the extension of tenure for Large Value Funds for Accredited Investors (LVFs). Under these rules, LVFs can extend their tenure by up to five years, but this requires the approval of two-thirds of the unit holders. For LVFs that have not disclosed an extension period or have an extension period exceeding five years, SEBI has mandated that they align with the five-year limit by November 18, 2024. These funds must also submit an undertaking to SEBI confirming their compliance with this requirement.

SEBI has further instructed that LVFs must update their extension details in the quarterly report for the quarter ending December 31, 2024. This measure ensures that all relevant information is communicated promptly to investors and regulators alike.

Migration Guidelines for Venture Capital Funds

SEBI has also outlined the process for Venture Capital Funds (VCFs) registered before the introduction of the AIF regulations to transition to the current AIF framework. VCFs with unliquidated investments after the end of their scheme tenure can opt to migrate to the AIF regulations by July 19, 2025.

VCFs choosing to migrate must submit their original registration certificate and specific information as required by SEBI. Post-migration, existing investors, investments, and units will be transferred under the AIF regulations without any changes. This migration option provides VCFs with a streamlined path to align with current regulatory standards while continuing their investment activities.

For VCFs that do not opt for migration, SEBI has indicated that they will be subject to enhanced regulatory reporting requirements. VCFs with expired schemes that fail to migrate may face regulatory action, as SEBI seeks to ensure compliance across all investment funds operating within the Indian market.

Conclusion

SEBI's new guidelines represent a significant step towards enhancing the regulatory framework governing alternative investment funds in India. By setting clear conditions for borrowing and tenure extension, SEBI aims to protect investors while ensuring that AIFs operate with greater transparency and financial discipline. The option for VCFs to migrate to the AIF framework further aligns the industry with contemporary regulatory practices, promoting stability and growth in the alternative investment space.

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