SEBI Plans to Change the Rules for Tracking Investments in PE and VC Funds This action is being taken by the market regulator in an effort to identify the investors and the source of the funds.

Securities and Exchange Board of India (SEBI) is likely to amend the regulations to begin monitoring investments going into local private equity (PE) and venture capital (VC) funds, according to a report.

This action is being taken by the market regulator in an effort to locate the investors and the source of the funds. Additionally, the ET report said that SEBI wants to determine whether PE and VC funds, also known as alternative investment funds (AIFs), are being utilised improperly.

A meeting was held to discuss the issue around two weeks ago, and only a few industry officials and subject-matter specialists attended. During this conference, new regulations to track the investments in AIFs were explored, as per the report.

"As the industry becomes large and influential, it is natural for the regulator to understand who the ultimate beneficial owner of the assets are. Consequently, in today's world where the source of capital is important and India's own regulations of restricting capital from "land border" rules, this was expected. As long as this does not cause an additional cumbersome burden on the managers, one has to comply and do the needful. SEBI may be encouraged to ask similar requirements from investors from other geographies as well so that all have a level playing field," said S Sriniwasan (Srini), Managing Director, Kotak Investment Advisors Ltd.

We Founder Circle Co-founder Gaurav VK Singhvi believed that it is essential to establish robust mechanisms to monitor the inflow of funds into AIFs to safeguard the integrity of the market. The information gathered from tracking investments can be instrumental in several ways. Firstly, it can help SEBI identify any potential sources of illicit funds, allowing them to take necessary actions to prevent money laundering and other illegal activities. Secondly, identify any potential way to sidestep FDI restrictions. Additionally, tracking investments can help identify instances of roundtripping and ensure compliance with regulations and reporting requirements, holding both fund managers and investors accountable for their actions.

Singhvi further highlighted that the new rules should not impose excessive burdens or restrict the operations of fund managers and investors. "Clear guidance, reasonable reporting requirements, and support for compliance will be essential in promoting a smooth transition and minimizing any adverse effects on the industry," he added.

What is SEBI worried about?

Investments in domestic AIFs are allowed from both domestic and foreign companies. Additionally, there are no rules guiding the structure of AIFs. A group of investors, or even just one domestic or international investor (limited partners), might establish an AIF.

These funds are typically incorporated in India, and when one of these AIFs invests in a domestic company, it is seen as a local investment even if an AIF's limited partners are entirely foreign entities. According to the report, in such a scenario, the fund's equity stake in an Indian company is not regarded as a foreign direct investment (FDI).

This mechanism enables AIFs to get around FDI restrictions. Additionally, it gives local promoters the opportunity to indirectly acquire ownership in a company.

Currently, SEBI does not automatically request information about AIF investors. Tejesh Chitlangi, a senior partner at IC Universal Legal, is quoted in the ET story as adding that SEBI might, in an exceptional circumstance, seek for these details after these considerations.

According to Prashant Narang, the Founder of Agility Ventures, this move will bring more transparency and accountability in the industry, which will increase investor confidence and attract more institutional investors to the market. It will also help to weed out bad actors and ensure that the funds are being used for their intended purpose.

On the other hand, as per Narang, this might also lead to more compliances, which could raise expenses, complicate fund-raising efforts for fund managers, and discourage investors to participate. Some investors might have concerns since "the disclosure of the investors' identities may compromise the confidentiality of the investment process."

Punit Shah, Partner at Dhruva Advisors, thought that it's a good move by SEBI to track and identify the source of funding for PE and VC firms. "Similar KYC norms by SEBI do exist for identifying the ultimate beneficial owner (UBO) of investors in FPIs. Even from a tax perspective, it would be important to identify the source of funds to avoid any tax litigation with the revenue authorities," Shah stated.