On February 3, 2023, the Securities and Exchange Board of India (SEBI) issued five consultation papers proposing changes in the regulatory norms for Alternative Investment Funds (AIFs). The publication of the consultation papers reflects SEBI’s continued focus and interest in the development of AIFs since it issued its first AIF regulations more than a decade ago.
The documents proposing the next generation of alternative mutual fund reforms aim to bring honesty and transparency to investors. We believe that the proposals in the articles if implemented, would bring about a massive change in the AIF sector in terms of
(i) transparency and (ii) portability for investors.
1. Transparency
a) Participation of an investor in the “direct plan” and then payment of the distributor’s commission.
The latest releases, which seek feedback from industry participants, serve two purposes:
- Alternative investment funds offer their investors direct debit, and
- Creation of a fee model for distributors of alternative investment funds. Similar practices have already been implemented in the fund sector and received positive feedback from both investors and the fund community. Mutual funds offer both regular and direct plans. In the case of a conventional arrangement, the investor invests through a broker and, due to the premium
charged by the broker, has to bear higher costs than if he had invested directly in the systems. The Direct plan does not include any marketing or investment fees.
With the publication of the consultation document, it became clear that the regulator is asking for changes in line with the fund industry to make the operation of alternative investment funds more transparent. Offering participation in AIFs through direct schemes will not only attract more investors but will also help distributors in the long run by adopting the remuneration model proposed by SEBI.
In the mutual fund industry, Trail fees are calculated as a percentage of the distributor’s assets under management and are paid quarterly. Since they are calculated on the basis of net assets, distributors benefit from an increase in their assets in the form of an increase in the net value of the funds or the sale of more units. The investor does not have to worry about the subsequent fees, because they are considered in the expense ratio, which is explicitly stated by all funds. These are not hidden costs affecting NAV.
SEBI’s proposal to pay 1/3rd distribution fee (present value) upfront (need for some reasonable incentives) and the remaining 2/3rd in installments will benefit the industry in the medium to long term. The proposal is expected to significantly reduce opportunities for mis-selling of alternative mutual fund schemes and bring transparency to investors.
b) Conflict of interest
Alternative investment funds can trade with their affiliates by investing in affiliates, buying/selling securities to farmers/farms, using their services, etc. However, such related transactions may create a conflict of interest.
While existing regulations already have provisions to deal with such conflicts of interest, SEBI in its advisory paper has specifically recommended that AIFs
cannot enter into such related transactions without the consent of 75% of investors, calculated on the basis of the value of their investments. AIF.
- colleagues;
- units of alternative investment funds managed or sponsored by its manager, sponsor, or affiliates of its manager or sponsor.
We welcome the change because current industry and regulatory issues related to related party transactions will be resolved. With this proposal, the most important thing is to ensure that the asset manager does not leave investors in the dark about investments related to bad investment investments of subsidiary companies.
2. Transferability – Dematerialization of Shares
SEBI has noted that despite the existing regulations on the issuance of AIF units, the majority of AIF units are still dematerialized and are held in physical form. As of now, the market regulator has proposed to make dematerialization of AIF units mandatory whereby all AIF schemes with a corpus of more than INR 500 will have to dematerialize their units by April 1, 2024.
The marketability of any instrument is severely affected. if the instrument is held in physical form. It is therefore an important step to promote alternative investment fund products and create access to a wider market. It also allows investors to adequately monitor their AIF investments as they can better see cash flows and returns, making it easier for them to decide whether to sell or dispose of units.
The next logical step in this regard would be to list the units because dematerialization would allow the units to be seen, but investors cannot trade the units in the open market unless they are listed.
To ensure liquidity in the field of alternative investment funds, the development of the secondary market of alternative investment funds is
necessary. As per Section 1 of the SEBI AIFM Rules, units of closed AIFMs can be listed on the Stock Exchange after the final closure of the scheme in a tradable lot of INR 1 crore or more. A listing of AIF shares would give investors an easy exit option (KYC compliant) and enable price discovery in a supply-demand mechanism.
Alternate Investment Funds are the ideal diversification products for high- net-worth individuals, institutional and corporate customers. To know more about Alternative Investment Funds or to explore the potential of investing in AIFs contact team Rurash Financials today or write to aif@rurashfin.com
