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SEBI CIRCULAR ON DUE DILIGENCE FOR ALTERNATIVE INVESTMENT FUNDS




On October 8, 2024, the Securities and Exchange Board of India (SEBI) issued a significant circular (SEBI/HO/AFD/AFD-POD-1/P/CIR/2024/135) focused on enhancing the due diligence requirements for Alternative Investment Funds (AIFs). This regulatory framework aims to ensure that AIFs and their managers are vigilant in their investor selection processes and investment decisions, thereby preventing circumvention of existing laws. Below, we outline the critical elements of this circular and its implications for AIFs.


Overview of the Circular

The circular is anchored in Regulation 20(20) of the SEBI (Alternative Investment Funds) Regulations, 2012, which mandates specific due diligence related to investors and their investments. The recent amendments emphasize the need for rigorous checks to prevent any facilitation of regulatory circumvention, particularly in relation to:

1. ICDR Regulations: AIFs, designated as Qualified Institutional Buyers (QIBs), must ensure that they do not allow ineligible investors to access benefits associated with QIB status.

2. SARFAESI Act: Similar due diligence is required for AIFs as Qualified Buyers (QBs) to ensure compliance with benefits available under the SARFAESI Act.

3. RBI Prudential Norms: The circular addresses concerns about the ever-greening of stressed assets by RBI-regulated lenders through AIFs.

4. NDI Rules: Investments from countries sharing a land border with India require special scrutiny to ensure compliance with regulatory stipulations.


Specific Due Diligence Requirements

1. Investors Availing QIB Benefits

AIFs must conduct thorough due diligence on investors contributing 50% or more to the corpus of a scheme. This includes verifying that these investors meet the eligibility criteria for QIB status under ICDR Regulations.

2. Investors Availing QB Benefits

Similar due diligence is mandated for investors who qualify for benefits under the SARFAESI Act. AIFs must ensure that these investors are not circumventing restrictions on QBs.

3. Ever-Greening of Stressed Assets

AIFs associated with RBI-regulated entities must perform due diligence on investors contributing significant amounts to the scheme. This measure aims to prevent regulatory breaches regarding asset classification and provisioning.

4. Investments from Land Border Countries

For any scheme where a significant portion of the corpus is contributed by investors from countries sharing a land border with India, due diligence checks are required to ascertain the legitimacy of the investment.


Reporting and Compliance

AIFs are tasked with reporting their due diligence outcomes to their custodians by specified deadlines. For existing investments that fail due diligence checks, AIFs must report these discrepancies to custodians by April 7, 2025. If all existing investments are compliant, a declaration must be submitted to the custodian.

Custodian Responsibilities

Custodians will compile the reports from AIFs and submit comprehensive data to SEBI by May 7, 2025. This ensures a structured flow of information and accountability.


Conclusion

The SEBI circular on specific due diligence for AIFs marks a pivotal shift in regulatory oversight aimed at bolstering the integrity of the investment ecosystem in India. By imposing stringent due diligence requirements, SEBI seeks to safeguard investor interests and enhance the accountability of AIFs. All stakeholders in the investment landscape should prioritize compliance with these new standards to foster a more transparent and secure market environment.

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