SEBI begins hedge fund regulation

The Securities and Exchange Board of India (SEBI) on Monday released a paper on regulation of alternative investments, including hedge funds.

Alternative investment funds or AIFs have been classified into 9 categories.

Any fund operating as hedge fund shall be required to be registered as a strategy fund under AIF regulation.

Hedge funds would be allowed to use leverage as well as invest in complex structural products and in derivatives.

They will also be allowed to use leverage subject to a maximum leverage specified by the board; and use long or short strategies.
These funds would also have to disclose a fair amount of information.

Strategy funds would have to disclose ‘information regarding the overall level of leverage employed, the leverage arising from borrowing of cash or securities and the leverage arising from position held in derivatives, the reuse of assets and the main source of leverage in their fund,’ said the SEBI note.

Experts suggest that this is the first time that SEBI has attempted to regulate India domiciled hedge funds.

“There has been a lot of discussion in the context of foreign institutions which are hedge funds investing in India because there is a belief that they introduce volatility in the markets.This is the first time that India domiciled funds would be so classified and regulated,” said one lawyer who preferred to remain unidentified since he had not gone through the document in detail.

In addition to hedge funds, Strategy funds would include all funds which would not fall under the eight other categories for alternative investment funds created by SEBI.

Another first is the creation of an official category of private equity funds. These funds used to register themselves as venture capital funds at the time of registration.

Other categories include PIPE (acronym for private investment in public equity) funds, venture capital funds, debt funds, infrastructure equity funds, real estate funds, SME funds, social venture funds.

The minimum size of the AIF shall be Rs20 crore with a minimum investment of Rs1 crore or 0.1% of the fund size whichever is higher.

The AIF would not be allowed to invest in certain companies such as NBFCs and certain gold financing companies.

PIPE investments would be restricted to shares of small sized listed companies which are not in any of the market indices.    

They may be allowed access to non-public information while carrying out due diligence for PIPE transactions under a confidentiality agreement with restriction in dealing in securities for a particular time frame.

The total investment in venture capital funds cannot exceed Rs250 crore and the fund is not allowed to invest in any company promoted by any of the top 500 listed companies by market capitalisation or by their promoters.

Venture capital funds would be regulated under the AIF regulation, once it is in place while the earlier VCF Regulation would be repealed.

Foreign venture capital investor (FVCI) regime which was introduced in 2000, would be retained but amended to invest in different categories of AIFs such as SME Fund and the social venture funds. The former would invest primarily in unlisted small and medium enterprises while the latter is a category of funds which would invest in micro finance institutions.

The requirement of lock-in period of one year for pre-IPO investments would not be applicable in respect of investments made by PE Funds, SVF and SME Funds on the same lines as for VCFs.

Public comments have been invited till August 30, 2011.

Meanwhile portfolio managers would have to raise their ticket size from Rs5 lakhs currently to Rs25 lakhs, as well as segregate their client’s funds.

Portfolio managers who seek to pool assets such as for investing in unlisted securities should be required to register as an alternative investment fund.

Those not managing funds but only providing advise would have to register themselves as Investment Adviser under a separate regulation which would cover such fund managers as well as wealth managers.