Regulatory Updates – Half-yearly Report – September 30, 2024

A. SEBI UPDATES:

1) Matters related to Alternative Investment Funds (AIFs)/Venture Capital Funds (VCFs) approved by the SEBI in its board meetings:

1. SEBI has approved borrowing for Category I and II AIFs for up to 30 days to address temporary shortfalls in investor drawdowns during investments. The cost of borrowing must be charged to the specific investors responsible for the shortfall, and a 30-day cooling-off period is required between two borrowings to prevent rollovers.

2) SEBI Circulars:

a) SEBI Allows Dissolution Period for AIF and VCF Schemes:

• SEBI has allowed AIF schemes to enter a dissolution period to manage unliquidated investments instead of transferring them to a liquidation scheme. Schemes with expiring liquidation periods within three months may be granted an extension subject to SEBI’s conditions. Unsold illiquid investments during the dissolution period must be distributed in specie to investors, and an information memorandum must be filed with SEBI through a merchant banker.
• SEBI has introduced the Migrated Venture Capital Fund (MVCF) under Chapter III D of the AIF Regulations, covering funds previously registered under the SEBI (Venture Capital Funds) Regulations, 1996, and later as Category I AIF venture capital funds. Venture capital funds must register as MVCFs within 12 months of the notification, failing which SEBI may impose enhanced regulatory reporting requirements.

b) Modification in framework for valuation of investment portfolio of AIFs: The Master Circular has been updated to require that valuation of thinly traded and non-traded securities follow the SEBI Mutual Fund Regulations, effective for AIFs from March 31, 2025. Changes in valuation methodology for AIFs will not be considered a “Material Change,” but both old and new methods must be disclosed.

Independent valuers must now be Registered Valuer Entities with IBBI, and valuers need relevant qualifications.

The timeline for reporting valuation data by AIFs to benchmarking agencies has been extended from six to seven months, and trustees to AIFs must ensure compliance in the Compliance Test Report.

c) Summary of SEBI Circular on Due Diligence of AIF Investors and Investments: The SEBI circular outlines due diligence requirements for AIFs regarding investors and investments. It applies to AIFs designated as Qualified Institutional Buyers (QIB) and notified under the SARFAESI Act. For proposed investments, if due diligence checks are not satisfied, investors should be excluded, and necessary disclosures must be made. For existing investments, details must be reported to the custodian by April 7, 2025, and if checks are satisfied, AIF managers must submit an undertaking to the custodian.

RBI-regulated lenders/entities involved in the ever-greening of stressed loans/assets, where indirect investments must be monitored to avoid this practice. AIFs investing in or having investors from countries sharing a land border with India must report investments where they hold 10% or more of equity in investee companies within 30 days for proposed investments and by April 7, 2025, for existing ones. A custodian is required to compile and report the information to SEBI by May 7, 2025.

d) Summary of SEBI Guidelines on AIF Investor Rights and Differential Rights: SEBI has clarified that investors in Alternative Investment Funds (AIFs) generally hold pro-rata rights to investments and distribution proceeds based on their commitment, with exceptions for excluded or defaulting investors. Returns like carried interest may not follow pro-rata distribution. Certain entities, including AIF managers, sponsors, and government-owned organizations, may bear more or less than their pro-rata share through subordinate units. AIFs with priority distribution models must cease accepting new commitments or investments unless compliant with new regulations. Differential rights can be offered to select investors without affecting others’ rights, provided they are transparently disclosed in the Private Placement Memorandum (PPM). AIFs must follow SEBI’s forthcoming standards on differential rights by January 15, 2025, with managers required to report and terminate rights that negatively impact other investors. Large Value Funds (LVFs) may offer such rights with proper disclosures and investor waivers.

e) AIFs Growth and Cybersecurity Compliance- SEBI’s New Framework for Resilience: Over the past five years, the Alternative Investment Funds (AIFs) sector has grown rapidly, with a compound annual growth rate (CAGR) of 26%, outpacing mutual funds. By 2028, the industry is expected to reach ₹64 lakh crore. However, the financial sector has been increasingly targeted by cyber-attacks, with over 20,000 incidents and significant financial losses. To address these risks, SEBI introduced the Cybersecurity and Cyber Resilience Framework (CSCRF) for Regulated Entities (REs), including AIFs, on August 20, 2024. This framework integrates India’s CERT-IN Cyber Crisis Management Plan and the globally recognized NIST Cybersecurity Framework. Compliance with CSCRF requires AIFs to categorize their entities at the start of the financial year based on previous data, with higher-category provisions applying to those falling under multiple categories.

(B) Income tax updates:

1. Simplified Holding Periods: Long-term gains now apply to listed securities held for over one year and other assets held for over two years, replacing the earlier three-tier system.
2. Revised Tax Rates: Short-term capital gains on listed equities increased to 20% from 15%. Long-term gains are taxable at 20% with indexation or 12.5% without indexation, while indexation benefits were removed for most assets but retained for specific land and buildings.
3. Abolition of angel tax: The tax on investments exceeding the fair market value in unlisted companies was removed, benefiting startups and early-stage businesses.

(C) RBI Updates:

1. Amendments to NDI Rules and Share Swap Transactions: The NDI Rules now permit equity swaps between Indian companies and foreign entities, including between residents and PROIs. Government approval is required for all cases, not just those under specific sectors. The rules also extend to downstream investments by NRIs, OCIs, and entities controlled by them on a non-repatriable basis. The sectoral cap limit has been revised, removing the 49% cap. Updates include changes to control and start-up company definitions, and FDI in White Label ATM operations is now under the automatic route. Additionally, rights shares renunciation by residents is allowed, permitting PROIs to acquire equity on a non-repatriable basis.