On August 19, 2024, the Securities and Exchange Board of India (SEBI) issued a significant circular (SEBI/HO/AFD/AFD-POD-1/P/CIR/2024/112) outlining new guidelines for Category I and Category II Alternative Investment Funds (AIFs) regarding their borrowing practices and the maximum permissible limit for extending the tenure of Large Value Funds for Accredited Investors (LVFs). This development comes in the wake of amendments to the AIF Regulations, 2012, notified on August 6, 2024.
A. Guidelines for Borrowing by Category I and Category II AIFs
Under the revised regulations, Category I and Category II AIFs—traditionally restricted from engaging in borrowing or leverage for investments—now have a more flexible framework for managing short-term funding gaps:
1. Borrowing for Temporary Needs: Previously, these funds could only borrow to meet temporary operational needs or shortfalls for up to thirty days on no more than four occasions annually, with the limit set at ten percent of the investable funds. The new guidelines add a provision to facilitate borrowing specifically to address temporary shortfalls in amounts called from investors for investment purposes.
2. Conditions for Borrowing:
Disclosure Requirement: AIFs must disclose any intention to borrow to meet shortfalls in drawdown amounts in the Private Placement Memorandum (PPM) of the scheme.
Emergency Use: Borrowing is only permitted in emergency situations where an investment opportunity is imminent and the drawdown amount has not been received despite efforts.
Limits on Borrowing: The borrowing cannot exceed the lesser of twenty percent of the proposed investment in the investee company, ten percent of the investable funds, or the commitment pending to be drawn from investors who failed to provide the drawdown.
Cost Allocation: Costs associated with the borrowing should be charged only to those investors who did not meet their drawdown obligations.
Cooling-Off Period: A thirty-day cooling-off period between borrowing instances is mandatory, calculated from the date of repayment of the previous loan.
3. Reporting and Transparency: Details regarding the amount borrowed, terms of the borrowing, and repayment schedules must be communicated to all investors on a periodic basis.
B. Maximum Permissible Limit for Extension of Tenure by LVFs
For Large Value Funds (LVFs), SEBI has clarified the maximum permissible extension period:
1. Extension Limits: LVFs can extend their tenure by up to five years, contingent upon approval from two-thirds of unit holders by value. Existing schemes that either did not specify a definite extension period or whose extension period exceeds five years must adjust their tenure in compliance with this regulation by November 18, 2024.
2. Realignment and Consent:
Realignment: LVF schemes must align their extension periods with the new limits and report this in their quarterly report for the quarter ending December 31, 2024.
Investor Consent: LVF schemes wishing to revise their original tenure must obtain and submit an undertaking to SEBI by November 18, 2024, confirming that all investor consents have been obtained.
3. Compliance Reporting: Trustees and sponsors of AIFs must ensure that compliance with these new guidelines is reflected in the Compliance Test Report prepared by the manager.
Conclusion
This move underscores SEBI’s commitment to adapting regulatory frameworks in response to evolving market needs while safeguarding investor interests. This circular, effective immediately, is designed to enhance operational flexibility and investor protection within the AIF sector. By allowing Category I and II AIFs more latitude in managing temporary funding gaps and clarifying the rules surrounding LVF tenure extensions, SEBI aims to promote better management practices and transparency.
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