NAVIGATING FUND MANAGEMENT REGULATIONS – SEBI AND IFSCA

Alternative Investment Funds (AIFs) have become crucial mechanisms for directing investments into emerging sectors such as startups, infrastructure, and private equity.In India, these funds are governed by two separate regulatory frameworks: the SEBI (Alternative Investment Funds) Regulations, 2012, and the IFSCA (Fund Management) Regulations, 2022. The SEBI regulations primarily focus on domestic investments, while the IFSCA regulations are designed to establish India’s International Financial Services Centres (IFSCs), particularly GIFT City, as global financial hubs.

1. OVERVIEW OF REGULATORY AUTHORITIES

SEBI

The Securities and Exchange Board of India (SEBI), established under the SEBI Act, 1992, oversees the regulation of domestic financial markets, including AIFs. SEBI’s primary objectives include investor protection, market transparency, and promoting investments in critical sectors like infrastructure and startups.

IFSCA

The International Financial Services Centres Authority (IFSCA), established under the IFSCA Act, 2019, regulates financial services within designated IFSCs. The IFSCA framework is designed to attract international investors and align with global financial norms.

2. KEY OBJECTIVES

SEBI AIF Regulations:

• • Encourage domestic economic expansion by allocating funds to vital industries.
  • Give alternative investments a well-organised framework.
  • Make sure there are strong safeguards for investors.
  • Increase the transparency of the market
  • Encourage new economic ecosystems, such as infrastructure and businesses.
  • Encourage the strategic allocation of capital in key national industries.
  • Put thorough risk management techniques into practice.
  • Establish regulatory frameworks for varied investment strategies.

IFSCA Fund Management Regulations:

• • Place International financial services centres in India as centres for international investment
  • Draw in foreign fund managers and investors.
  • Regulating frameworks in accordance with international financial standards
  • Establish investment environments that are flexible and competitive.
  • Encourage international investment channels
  • Encourage investments in cutting-edge industries like fintech and ESG
  • Lower regulatory obstacles to global financial involvement
  • Create globally acclaimed money management procedures.
  • Give international investors tax and structural benefits.

3. REGISTRATION REQUIREMENTS:

SEBI AIF Regulations:

• • Registration process: Entities must fulfil certain requirements to register as an Alternative Investment Fund (AIF) under the Securities and Exchange Board of India’s (SEBI) regulations.
    SEBI AIF Registration Requirements The legal structure of a business must be established as a trust, limited liability partnership (LLP), or company. It cannot be a Registered FME (Retail) if it is set up as an LLP.
  • AIF Categories: –
    – Category I: Funds that make investments in social ventures, small and medium-sized businesses (SMEs), or start-ups.
    – Category II: Funds that are allowed to raise money from investors but do not fit into either Category I or III.
    – Category III: Funds that may use leveraged investments and use a variety of intricate trading tactics.
  • Minimum Net Worth: The applicant needs to meet SEBI’s minimum net worth requirements. For example, Category I AIFs usually demand a minimum net value of ₹5 crore. An established track record in money management or comparable disciplines is a prerequisite for experience. It is generally preferable to have at least five years of experience.
  • Application Submission: Send a completed application to SEBI, including the required paperwork and payment. Applications with errors may be denied. Establish a compliance officer who will be in charge of making sure that rules are followed. A thorough description of the investment strategy, target investors, and risk management procedures must be included in the application. The profile of the fund manager or managers must include information about their credentials and experience.

IFSCA Fund Management Regulations

• Registration Process: Entities must obtain a certificate of registration from the Authority before starting fund management operations.
• There are three categories for registration:
  • Authorised FME: For private placements and venture capital investments.
  • Registered FME (Non-Retail): For private placements and portfolio management services targeting accredited investors.
  • Registered FME (Retail): For public offerings and retail schemes without investor limits.

4. FUND CATEGORIZATION

SEBI AIF Regulations

AIFs under SEBI are divided into:

1. Category I: Promotes investments in economically beneficial areas (e.g., venture capital, infrastructure funds).
2. Category II: Includes private equity and debt funds that do not receive specific incentives.
3. Category III: Comprises hedge funds and other funds employing complex strategies.

IFSCA Fund Management Regulations

Funds in IFSCs are classified into:

1. Retail Funds: Accessible to retail investors, with lower thresholds.
2. Restricted Funds: Target institutional and high-net-worth investors.
3. Specialized Funds: Focus on areas like ESG (Environmental, Social, and Governance), fintech, and private equity.

5. FUND STRUCTURES

SEBI AIF Regulations

Funds can be structured as:

• Trusts
• Limited Liability Partnerships (LLPs)
• Companies
• Bodies Corporate

These structures cater to India’s domestic investment environment.

IFSCA Fund Management Regulations

Funds under IFSCA allow:

• Segregated Portfolio Companies (SPCs): Facilitates asset and liability segregation within a single entity.
• Variable Capital Companies (VCCs): Proposed introduction for greater operational flexibility (common in jurisdictions like Singapore).
• Traditional structures like trusts and LLPs.

6. COMPLIANCE AND REPORTING

SEBI AIF Regulations

• Registration: Mandatory with SEBI, requiring detailed disclosures on objectives, investor profiles, and strategies.
• Minimum Investment: ₹1 crore for each investor.
• Leverage: Restricted for Category I and II funds.
• Reporting: Regular quarterly and annual reports are mandatory.

IFSCA Fund Management Regulations

• Registration: Simplified processes tailored for international participants.
• Investment Thresholds: Relaxed requirements, especially for retail funds.
• Leverage: Permissible for sophisticated funds, adhering to global norms.
• Reporting Standards: Align with international best practices for transparency.

7. TAXATION FRAMEWORK

SEBI AIF Regulations

• Category I and II Funds: Tax pass-through status; income is taxed at the investor level.
• Category III Funds: Income is taxed at the fund level, resulting in higher effective taxation.
• Standard domestic taxation laws apply, which can be less attractive to foreign investors.

IFSCA Fund Management Regulations

Funds in IFSCs benefit from a favourable tax regime:

• Capital Gains Tax: Exemptions for non-residents.
• Withholding Tax: Lower rates on interest income.
• GST Exemptions: On fund management services. These incentives make IFSCs competitive compared to global hubs like Dubai or Singapore.

8. INVESTMENT FOCUS AND STRATEGIES

SEBI AIF Regulations

• Primarily focused on investments within India.
• Targets sectors like startups, small and medium enterprises (SMEs), and social impact ventures.

IFSCA Fund Management Regulations

• Emphasizes cross-border investments.
• Supports innovative sectors like ESG, global real estate, and fintech.

9. RECENT DEVELOPMENTS

SEBI AIF Regulations

• ESG Norms: Introduced mandatory disclosure requirements for funds focusing on ESG investments.
• Strengthened Governance: Updated rules on fund operations to improve investor confidence.

IFSCA Fund Management Regulations

• VCC Framework: Proposed introduction of Variable Capital Companies to enhance operational flexibility.
• Global Collaborations: Agreements with international regulators to streamline cross-border investments.

10. Comparison Table

Conclusion

The SEBI AIF Regulations and IFSCA Fund Management Regulations represent distinct approaches to fostering alternative investments. While SEBI focuses on domestic economic priorities and investor protection, IFSCA offers a globally competitive framework with tax incentives and structural flexibility. Together, these frameworks provide a robust foundation for India’s financial sector, enabling it to cater to both domestic and international investors effectively.

The choice between these frameworks depends on the investment strategy, geographical focus, and regulatory preferences of fund managers and investors. As India’s financial landscape evolves, these complementary regulations will play a pivotal role in driving the country’s growth and global integration.

Author: Pooja Chatterjee and Aribba Siddique