Securities and Exchange Board of India (SEBI) has begun the new year on a strong note, bringing into effect its November 2023 Board decisions that among other things extended the requirement of mandatory appointment of custodians by Alternate Investment Funds (AIFs) to schemes with corpus less than or equal to ₹500 crore. 

Till now, this mandatory Custodian appointment norm was applicable to Category III AIFs and to Category I and II AIFs with corpus more than ₹500 crore. Now it stands extended to all AIFs.

The market regulator has effective January 5 this year amended its 2012 framed AIF Regulations to also stipulate that AIFs can hold securities of their investments only in dematerialised form subject to certain exceptions.

The exclusions are investments by AIFs in instruments which are not eligible for dematerialisation; investments held by a liquidation scheme of AIF that are not available in dematerialised form. 

SEBI has also now empowered itself to specify in future such other investments by AIFs or such other schemes of AIFs that need not be covered under dematerialisation requirement.

• Also read: Banks looking to exit AIF units may run into wall

The move to mandate AIFs to hold their investments in dematerialised form will enhance transparency, reduce risk and provide comfort to investors, say experts.

This will also encourage digitalisation of financial markets in India, to facilitate access to the market and ease of doing business, they said. The dematerialisation requirement will align AIFs with national priority, it was felt.

NEW CONDITIONS 

AIFs can now appoint a Custodian who is an Associate of a Manager or a Sponsor of an alternate fund only when certain conditions are met. 

At all points of time, the Sponsor or Manager should have minimum net worth of ₹ 20,000 crore. Also, fifty percent or more of the directors of the Custodian do not represent the interest of the Sponsor or Manager or their associates. The Custodian and the Sponsor or Manager of the AIF are not subsidiaries of each other and they do not have common directors. 

SEBI also now wants the Custodians and the Manager of the AIF sign an undertaking that they would act independently of each other in their dealings of the schemes of the Fund.

• Also read: Decoding RBI’s new rules on bank investments in AIFs 

REGULATORY GAPS 

The latest changes by SEBI in its AIF regulations comes at a time when regulators (including RBI) have moved fast to close various regulatory gaps that led to breaches in the spirit of law and the use of such investments vehicles for escaping regulatory oversight. 

Recently, RBI in an apparent bid to address concerns of possible ever-greening through the AIF route tightened the norms for banks and NBFCs investing in such investment vehicles.

The central bank had, in the third week of December 2023, directed banks and NBFCs to not make investments in any AIFs that has downstream investments either directly or indirectly in a borrower of the bank.

• Also read: RBI clamps down on evergreening of stressed loans via the AIF route