News and developments
SEBI’S PROPOSAL FOR PROVIDING EXITS FROM AIFS – A CRITIQUE
The Consultation Paper has listed out the options presently available to an AIF and the investment manager of the AIF (“Investment Manager”) upon expiry of the tenure of a scheme of the AIF. Under the existing SEBI AIF Regulations, AIFs (other than Large Value Funds for Accredited Investors (“LVF”)) may extend the tenure of a scheme only up to two years, subject to receiving the approval of two-thirds of the investors by value of their investment in the AIF.[1] LVFs are permitted to extend their tenure beyond two years, subject to the terms of their fund documents and such conditions as may be specified by SEBI from time to time. At the end of their term (including any extension of the term) AIFs may distribute the assets of the AIF in-specie, after obtaining the approval of at least 75% of the investors by value of their investment in the AIF.[2] In case in-specie distribution of residual assets does not take place, AIFs are required to fully liquidate the scheme within one year following expiration of the tenure of the AIF.
The Consultation Paper states that SEBI has, in the recent past, received requests from a few AIFs seeking permission for extension of the tenure of their schemes citing reasons such as lack of liquidity, legal / regulatory impediments, etc. In this context, sample data collected by SEBI for expiry of the tenure of schemes of AIFs suggests that the two-year extension period for 24 schemes of AIFs with a valuation of Rs. 3,037 crores will expire in FY 2023-24. Further, the tenure of another 43 schemes with a valuation of Rs. 13,450 crores will expire in FY 2024-25. In light of this, SEBI’s Consultation Paper has put forth a proposal to provide an additional option to AIFs and their investors to carry forward unliquidated investments of a scheme beyond the currently permitted two-year extension of tenure.
SEBI is of the view that ensuring proper recognition and disclosure of true asset quality, liquidity, and fund performance by AIFs/ Investment Managers is a regulatory objective. A full closure of the scheme, recognition of the true asset value, and re-opening of a fresh fund at that value would satisfy both objectives of providing additional flexibility to investors/ funds, while ensuring disclosure and tracking of true asset value and fund performance.
SEBI’s Proposal
Transfer of unliquidated investments to a new scheme
SEBI’s Alternative Investment Policy Advisory Committee (AIPAC) has recommended that at the end of a scheme’s tenure (which would include the permitted two-year extension), instead of liquidating all investments, the AIF may transfer the unliquidated investments to a new scheme, provided not less than 75% of the AIF’s investors by value consent to the same. Investors who do not consent to such transfer of unliquidated investments to a new scheme (“Dissenting Investors”) have to be given an exit. In order to give an exit for the Dissenting Investors, the AIF or its Investment Manager has to arrange bids for a minimum of 25% of the unliquidated investments. If the minimum 25% bid is obtained from related parties of the AIF/ Investment Manager/ sponsor or from other existing investors, the same should be transparently disclosed to all investors. The Consultation Paper says, “such bids can only be used to provide pro-rata exit to other remaining investors”. We assume this means that the bids obtained from related parties of the AIF/ Investment Manager/ sponsor or from other existing investors can only be used to provide pro-rata exit to Dissenting Investors. However, wouldn’t even bids from persons other than related parties of the AIF/ Investment Manager/ sponsor or from other existing investors be used only to provide an exit to Dissenting Investors?
What if fresh bids for a minimum of 25% of unliquidated investments cannot be obtained?
The obligation to arrange fresh bids for a minimum of 25% of unliquidated investments does not appear to be mandatory since the Consultation Paper states that where such bids cannot be arranged, the closing valuation of the scheme will be based on the liquidation value as determined under IBBI (Insolvency Resolution Process for Corporate Persons) Regulations, 2016, or other applicable IBC norms (“IBBI Liquidation Value”). However, if bids are received for a minimum of 25% of unliquidated investments, even if such bids are for a value lower than the IBBI Liquidation Value, the unliquidated investments can be transferred to the new scheme at the bid value and the IBBI Liquidation Value is irrelevant.
Further, even if bids for a minimum of 25% of unliquidated investments are not obtained, an exit has to be provided for all Dissenting Investors. The Consultation Paper states that the, “value at which the aforementioned exit is proposed to be provided to Dissenting Investors, along with the valuation carried out by two independent valuation agencies, shall be disclosed to all investors”. Though the Consultation Paper does not spell it out in as many words, in our view, even if the valuation arrived at by two independent valuation agencies is higher than the value offered by the bidders or, in the absence of bids, the IBBI Liquidation Value, the transfer of the unliquidated investments can take place at the lower value provided a full disclosure is made to the investors.
Though the Consultation Paper does not expressly say so, it is clear that, the AIF should make best efforts to obtain bids for a minimum of 25% of the unliquidated investments before seeking investor consent for the proposal to transfer unliquidated investments to a new scheme. This is because investors in the AIF would need to know the value of bids received (or if there are no bids, the IBBI Value), before deciding whether to consent to the proposal or not.
Payment to Dissenting Investors
The Consultation Paper does not expressly state when the Dissenting Investors should be paid for their units in the AIF. If bids are received for 25% of unliquidated investments, it would be possible to pay the Dissenting Investors prior to or simultaneously with the transfer of the unliquidated investments from the old scheme to the new scheme. If no bids are received and Dissenting Investors are to be paid at the IBBI Liquidation Value, where would the money to pay the Dissenting Investors come from? Should the AIF somehow dispose of a portion of the unliquidated investments to generate the monies needed to pay the Dissenting Investors? Do remember, this would be a scenario where despite the best efforts of the AIF and its Investment Manager, bids could not be obtained for even 25% of the unliquidated investments.
When the unliquidated investments are transferred from the old scheme to the new scheme, would the old scheme be paid for such transfer? The Consultation Paper is silent on this point. Since atleast 75% of the investors in the old scheme should have consented to the transfer, such investors would become investors in the new scheme and such investors would not pay cash to the new scheme for their units. They would instead swap the units of the old scheme for units of the new scheme and new scheme would not receive any cash from its investors. It is possible that all the investors in the new scheme were investors in the old scheme. If some of the investors in the new scheme are from the old scheme and the rest are not, the new scheme would have a cash corpus which could be paid to the investors in the old scheme to provide them a partial exit. Alternatively, such new corpus could also be deployed in fresh investments.
The new scheme would need some cash for its operating expenses. Can the cash balance from the old scheme be transferred to the new scheme? Presumably yes, though the Consultation Paper is silent on this point.
If bids were not received for 25% of unliquidated investments and the Dissenting Investors couldn’t be paid for their units prior to the transfer of the unliquidated investments, the cash consideration paid to the old scheme by the new scheme, if any, could be used to pay the Dissenting Investors. However, it is possible that such cash consideration may not suffice to pay the Dissenting Investors at the time of transfer of the unliquidated investments.
Mid-way cancellation of the plan
If the Investment Manager does not like the bids received for 25% of unliquidated investments, can the Investment Manager cancel the proposed transfer of the unliquidated investments to a new AIF? Would the Investment Manager be required to inform the investors of the bids received even if the Investment Manager does not wish to transfer of the unliquidated investments to a new AIF? The Consultation Paper is silent on these points.
Computing the performance of the AIF’s Investment Manager
The Consultation Paper also provides that the performance of the AIF’s Investment Manager shall be computed in accordance with the value at which investors are provided exit or the IBBI Liquidation Value, as the case may be. Such performance data shall also be included in the track record of the Investment Manager in the private placement memorandum (“PPMs”) of subsequent schemes.
Disclosures to new investors
The Consultation Paper requires that fresh investors in the new scheme should be explicitly informed that the new scheme holds unliquidated investments from a previously closed scheme and the reasons thereof. It is presumed that this disclosure will be contained in the PPM of the new scheme.
Proposed exemptions for new schemes
The Consultation Paper provides that if a new scheme is being launched with the objective to only transfer unliquidated investments from old scheme, and not to make any new investment, then such scheme shall be exempted from the following provisions of the AIF Regulations:
- Minimum scheme corpus requirement [Regulations 10(b) and 19L(1)]: Regulation 10(b) of the AIF Regulations provides that each scheme of an AIF shall have a corpus of at least twenty crore rupees. Regulation 19L(1) provides that each scheme of a special situation fund shall have a corpus as may be specified by SEBI. Exemption from these provisions would mean that the new scheme would not be required to have the prescribed minimum corpus and even if the value of the unliquidated investments from the old scheme is less than the prescribed minimum corpus, the AIF would not be in breach of Regulation 10(b) or Regulation 19L(1) of the AIF Regulations. It is interesting to note that the Consultation Paper does not include Regulation 19D(2) in the list of exempt regulations. Regulation 19D(2) of the AIF Regulations prescribes a minimum corpus of five crore rupees for an Angel Fund.
- Minimum investment requirement from investor in scheme of AIF (Regulations 10(b) and 19L(2)): Regulation 10(b) of the AIF Regulations provides that an AIF shall not accept from an investor, an investment of value less than one crore rupees. Regulation 19L(2) provides that a special situation fund shall accept from an investor, an investment of such value as may be specified by the Board. Exemption from these provisions would mean that the new scheme may accept an investment of any value from its investors. Therefore, an AIF which launches a new scheme with the objective to only transfer unliquidated investments from an old scheme would find it easy to raise funds. It is interesting to note that the Consultation Paper does not include Regulation 19D(3) in the list of exempt regulations. Regulation 19D(3) of the AIF Regulations prescribes a minimum investment of twenty five lakh rupees from each angel investor in an Angel Fund.
- Requirement of fixed tenure [Regulation 13(1)]:Regulation 13(1) of the AIF Regulations provides that Category I AIF and Category II AIF shall be close ended and the tenure of fund or scheme shall be determined at the time of application, provided that such AIFs or schemes launched by such AIFs shall have a minimum tenure of 3 years. Exemption from this provision implies that a scheme which has been launched with the objective to only transfer unliquidated investments from an old scheme need not declare its tenure upfront in its PPM and may be wound down as soon as it fulfils its objective of liquidating/distributing the unliquidated investments of the old scheme.
- Investment concentration norms [Regulation 15(1)(c)]: Regulation 15(1)(c) of the AIF Regulations provides that Category I and II of AIFs shall invest not more than 25 % (twenty-five per cent) of the investable funds in an Investee Company directly or through investment in the units of other AIFs. The rationale for this exemption is amply clear since the ‘unliquidated investments’ of the new scheme may consist of less four investee companies. Also, one or more of such ‘unliquidated investments’ may hold more than 25% of the corpus of the new scheme.
- Make best efforts to arrange bids for a minimum of 25% of the unliquidated investments;
- Obtain a valuation for the unliquidated investments from two independent valuation agencies;
- Disclose to all investors:
- the value at which the exit is to be provided, either based on the bids obtained, or on the basis of the IBBI Liquidation Value; and
- the valuation for the unliquidated investments determined by two independent valuation agencies;
- Obtain the consent of not less than 75% of the investors by value of their investments for the proposed transfer to the new scheme;
- Provide an exit for all Dissenting Investors by selling a suitable portion of the unliquidated investments;
- Transfer the balance portion of the unliquidated investments to the new scheme; and
- Pay the old scheme for the unliquidated investments in cash using the contributions received from the investors in the new scheme or swap the units of the old scheme for units or the new scheme or apply a combination of these.
- the value at which the exit is to be provided, either based on the bids obtained, or on the basis of the IBBI Liquidation Value; and
- the valuation for the unliquidated investments determined by two independent valuation agencies
- Section III of the PPM format for Category I and Category II AIFs requires disclosures regarding the proposed AIF’s investment strategy and investment philosophy. Therefore, the fact that the unliquidated investments of a previous AIF are proposed to be purchased by such AIF after its initial closing need to be disclosed in this section. Further, the current valuation of the unliquidated investments sought to be transferred from the old AIF and the methodology adopted to reach such valuation should be disclosed upfront to the investors. The investors should also be informed of the valuation methodology that would be applied to calculate the price at which such unliquidated investments would be transferred to the new AIF.
- Section IX of the PPM format provides for disclosures regarding all potential sources of conflicts of interests that the Investment Manager envisages during the operations of the Fund/Scheme have to disclosed under this section. This section should highlight that the same person (i.e., the Investment Manager of the old and new AIF) shall make the investment decision of the seller as well as the buyer, with respect to the investments being transferred to the new AIF.
- Section X of the PPM format provides for disclosures regarding Risk Factors: This section should lay down as exhaustively as possible all potential risk factors that the investors needs to be aware of in respect of their investments in the Fund/Scheme, including risk associated with the nature of the portfolio investments (type of company, type of instrument, pricing, non-controlling stake/minority interest, as may be applicable) and risk related to the exit of the Fund/Scheme from the portfolio investments and possibility of distribution in kind. Under this section, it may be prudent to disclose the fact that the old AIF was unable to liquidate the investments, which are being bought by the new AIF, and perhaps also the market conditions which caused such inability to liquidate the said investments.