New rules for overseas investment by AIFM and private equity funds

Introduction

Foreign investments from alternative investment funds (“FAI“) and venture capital funds (“VCFs”) are governed by the guidelines prescribed by the Securities and Exchange Board of India (“SEBI“) from time to time. Until prior approval by the Reserve Bank of India (“RBI”) is not required for foreign investment, prior approval of SEBI is required for allocation of foreign investment limits to AIF/VCF. The current aggregate investment limit for foreign investment by FAIs and VCFs is USD 1,500,000,000 (One Billion Five Hundred Million United States Dollars) and these limits are allocated on a first-come, first-served basis subject to a limit of 25% of the invested funds per scheme of AIF/VCF. AIF/VCF should make investments in offshore entities within 6 (six) months from the date of approval by SEBI.

SEBI recently issued the guidelines for overseas investment by AIFMs and venture capital funds (“New directions”) on August 17, 2022, which sets out a revised framework for making overseas investments by AIFM and venture investment funds. Prior to the issuance of the New Guidelines and subject to other prescribed restrictions, AIFMs and VCFs wishing to invest in offshore investee companies were permitted to make investments in such offshore companies which had an “India connection” (ie. f. offshore companies that had back-office operations in India).

With the new guidelines now in place, such pooled investment vehicles are no longer restricted by the ‘India nexus’ requirement in relation to their offshore investments.

The new guidelines are in addition to the earlier guidelines issued by SEBI in this regard (except to the extent modified by the new guidelines).

The new guidelines

  1. Eligibility criteria for a foreign investee company: According to the new guidelines, FIUs and VCFs can invest in offshore companies that:
    1. are entities incorporated in countries whose securities market regulator is a party to the multilateral memorandum of understanding of the International Organization of Securities Commissions (signatories to Annex A) or a party to the bilateral memorandum of understanding with SEBI; and
    2. have not been identified by the Financial Action Task Force (“FATF”) in a public statement as: (i) a jurisdiction having strategic anti-money laundering or counter-terrorist financing deficiencies to which countermeasures apply, or (ii) a jurisdiction that has not made sufficient progress in addressing the deficiencies or has committed to an action plan developed with the FATF to address the deficiencies.
  2. Reworked application format: The new guidelines introduced a more detailed format for AIFMs and VCFs applying to SEBI for allocation of overseas investment limits. The revised format requires the provision of AIF and VCF Among others details of the overseas offshore company, type of intended investment and overseas investments made by the relevant AIFM or VCF in the past.
  3. AIF/VCF undertakings: Further, unlike the previous format, the revised format prescribes additional undertakings to be provided by the trustees/designated partners/board of the applicant AIFM and the AIFM in relation to: (a) the bona fide nature of the proposed overseas investment, (b ) the investment is in accordance with the investment objectives of the fund, and (c) compliance of the proposed foreign investment with the regulatory framework for foreign investments by FAI/FDF.
  4. Commitment from the manager of the applicant AIF/VCF: A detailed undertaking should also be submitted by the manager of the applicant AIF/VCF in relation to Among others the following:
    1. exercise of due care by the manager;
    2. the nature of the proposed instrument, which must be an equity or equity-related instrument;
    3. the proposed offshore investee is an offshore venture capital entity;
    4. the proposed offshore investee meeting the eligibility criteria prescribed under the New Guidelines;
    5. The AIF/VCF does not invest in joint ventures or wholly owned subsidiaries while making investments abroad;
    6. compliance with FEMA regulations and other RBI guidelines in respect of a structure that involves foreign direct investment under the foreign direct investment route;
    7. compliance with all requirements as per RBI guidelines for opening branches/subsidiaries/joint venture/undertaking of investment abroad by non-banking financial companies (“NBFCs“), where more than 50% of the funds of the AIF/VCF are contributed by a single NBFC; and
    8. the recipient entity to which the AIF/VCF sells/transfers its invested offshore unit is an entity that is eligible to make investments abroad in accordance with Indian foreign exchange laws.
  5. Reinvestment of sale proceeds: The new guidelines also clarify that the sale proceeds received by the AIFM or DFK from the liquidation of its offshore investees will be available for reinvestment.
  6. Sale/Sale Reporting:
    1. The new guidelines introduce the requirement to report to SEBI any sale/disinvestment by AIFM or DFK. Accordingly, SEBI has prescribed a format for reporting any sale/disinvestment by an AIFM or DFK. Such reporting must be done by the relevant AIFM or VCF within 3 (three) working days of the disinvestment by sending the report by email to [email protected]
    2. SEBI has further prescribed a one-time reporting by all AIFMs and VCFs of their previous sales/disinvestment in offshore entities by September 16, 2022 by sending the report via email to [email protected]

Comment by JSA

The new guidelines have certainly liberalized the previous regime that allowed FIIs and FCFs to invest only in overseas companies that had an “India connection”. Liberalization is coupled with additional investment safeguards and conditions that have been put in place for AIFMs and private equity funds wishing to invest offshore.

SEBI also reiterated its intention to increase the accountability of governing bodies and managers of AIFMs and VCFs involved in offshore investments as it sought additional commitments from them at the time of application seeking restrictions on offshore investments.

Although the liberalization under the New Guidelines is a step in the right direction, SEBI must eventually move to making overseas investments through the automatic route. The securities regulator should also consider whether AIFMs should be allowed to invest in debt instruments of overseas companies, as the current regulatory framework allows AIFMs to invest only in equity and equity-related instruments. In addition, the RBI should consider increasing foreign investment restrictions in the near future to enable Indian AIFMs and VCFs to compete with funds abroad.

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