Tighter AIF Norms Prompt Fund Managers to Consider Offshore Routes

Tighter AIF Norms Prompt Fund Managers to Consider Offshore Routes

Sub: Economy

Sec: Financial Market 

A number of sponsors and investment managers — especially those wanting to raise predominantly foreign capital — are considering taking the offshore route to invest in India instead of setting up alternative investment funds (AIFs) amid regulatory uncertainty and higher costs.

Key Points:

• Impact of Tighter Regulations:
  • Operational Challenges: Tighter regulations are affecting the operations of AIFs, causing managers to be wary of regulatory stability.
  • Consideration of Offshore Routes: Managers based in India looking to raise significant offshore capital are contemplating moving their base outside India to mitigate adverse regulatory impacts.
  • Expert Insight: Siddharth Shah, Senior Partner at Khaitan & Co, highlighted the shift due to regulatory uncertainties.
• Investor Concerns:
  • Regulatory Note: A recent note questioning the FDI policy around AIFs has alarmed investors.
  • Foreign Direct Investment (FDI) Policy: Foreign investors have been setting up AIFs with domestic managers to invest in sectors restricted for direct foreign investment or beyond allowed FDI limits.
  • RBI Recommendation: The Reserve Bank of India recommended treating investments exceeding 50% of AIF units by persons resident outside India as indirect foreign investment.
• Regulatory Shift:
  • Previous Amendments: In 2015-16, regulations were amended to allow AIFs to take foreign capital through the automatic route, considering the manager and sponsor’s ownership and control.
  • Current Stance: The recent regulatory stance represents a reversal, potentially undermining onshore management and pooling of foreign capital.
• Expert Opinions:
  • Impact on Growth: Vivaik Sharma, Partner at Cyril Amarchand Mangaldas, stated that regulatory subjectivity, especially conflicting with FEMA rules, would hinder the growth of alternative asset management in India.
  • Increased Compliance Costs: Ipsita Agarwalla from Nishith Desai Associates mentioned that increased compliance costs for AIFs are impacting the return profile, as these costs are typically passed on to investors.
• Additional Challenges:
  • Taxation and Administration: Uncertainty regarding the taxation of carry, difficulty in managing co-investments, and the introduction of an online dispute resolution regime for global institutions are also deterring investors.
  • Offshore vs. Onshore: Offshore funds benefit from more stable regulatory regimes, but tax considerations must be addressed, especially given recent changes in treaty benefits and substance requirements.
• GIFT City as an Alternative:
  • Regulatory Stability and Tax Benefits: GIFT City offers regulatory stability, tax incentives, and proximity to India, making it an attractive alternative for fund managers.

Conclusion

The tightening of AIF norms in India is prompting fund managers to explore offshore routes to mitigate regulatory uncertainties and costs. While offshore options provide stability, they come with their own tax considerations. GIFT City emerges as a potential alternative due to its regulatory advantages and incentives. The ongoing regulatory changes and their impacts highlight the need for a balanced approach to maintain India’s competitiveness in attracting and managing foreign capital.

Alternative Investment Funds (AIFs)

Alternative Investment Funds (AIFs) are investment vehicles that pool funds from investors and invest them according to a defined investment policy for the benefit of their investors. These funds typically invest in assets beyond traditional securities like stocks, bonds, and cash.

Key Points about AIFs:

• Category I AIFs:
  • Focus: Invest in start-ups, early-stage ventures, social ventures, SMEs, infrastructure, or other sectors considered socially or economically desirable.
  • Examples: Venture Capital Funds, Social Venture Funds, SME Funds, Infrastructure Funds.
  • Incentives: Often receive incentives or concessions from the government.
• Category II AIFs:
  • Focus: Invest in a variety of asset classes including private equity funds or debt funds that do not specifically fall under Category I or III.
  • Examples: Private Equity Funds, Debt Funds.
  • Characteristics: Do not get any specific incentives or concessions from the government or other regulators.
• Category III AIFs:
  • Focus: Employ diverse or complex trading strategies and may invest in derivatives.
  • Examples: Hedge Funds.
  • Characteristics: Typically leverage their investments and are subject to stricter regulatory scrutiny.

Regulation and Structure:

• Regulatory Body: AIFs in India are regulated by the Securities and Exchange Board of India (SEBI) under the SEBI (Alternative Investment Funds) Regulations, 2012.
• Investment Structure: AIFs can be established as a company, trust, or limited liability partnership (LLP) in India.