How SEBI is set to make AIFs more investor-friendly

AIFs—an investment avenue for high-net-worth individuals who have so far enjoyed light-touch regulation—are privately pooled investment vehicles that pool funds from sophisticated investors, requiring minimum investment requirements. is required. 1 crore in most cases. They are governed by SEBI regulations and are classified under three categories – I, II, or III (see graphic).

what’s coming

The first and foremost proposal of SEBI is that all AIFs should be mandated to offer investors a low-cost direct plan option that does not involve any distribution or placement charges. The 2012 AIF Regulations support direct plans, but this is optional. As a result, there are hardly any AIFs that offer them.

Second, SEBI wants AIFs to adopt the trail model of commission (wherein commission is paid periodically) to distributors instead of the widely practiced upfront payment of commission, which has resulted in widespread mis-selling of schemes. According to an industry person on condition of anonymity, distributors are now rushing to promote AIF schemes that have huge upfront commissions ahead of Sebi’s proposals to change the rules.

The current AIF regulations have no restrictions on the extent of commission that can be paid upfront. SEBI’s move is set to bring AIFs at par with mutual funds (MFs) and portfolio management services (PMS) – both of which have to offer direct plans and follow the trail model of commission.

Third, SEBI has also proposed mandatory dematerialisation of AIF scheme units – conversion of securities held in physical paper form into electronic form – to enable investors to track them easily. To be implemented in phases, with AIFs having more funds 500 crores offered in demat format by 1st April 2024.

Fourth, to provide an additional option to AIFs in situations where they are unable to redeem illiquid investments, SEBI has proposed that such investments be transferred to a new scheme with investor approval.

Direct Plan, Trail Commission

Currently, in the absence of direct schemes, there is no difference in cost, whether you invest in an AIF scheme through a distributor or directly through the AIF. In the latter case, the fund retains the amount that would have been paid to the distributor. Those investing in AIFs based on advice from financial advisors are charged twice – as advisory fee, and for AIF distribution fee. Once a direct plan is launched, investors in such plans will not have to bear the distribution cost. SEBI has proposed that AIFs should ensure that any investor approaching them through investment advisors invests only through the direct plan route.

Munish Randev, founder and CEO of Cervin Family Office & Advisors, says that the important thing to look at is whether the difference between regular and direct plans truly reflects what distributors or placement agents are being paid. Dipen Ruparelia, Head-Products, Vivriti Asset Management, SEBI proposes that AIF direct plan investors will be given operational savings for investors and AIF managers by offering a higher number of units (to account for lower expenses) instead of a lower NAV There can be challenges. “Like mutual funds where regular plan and direct plan investors have two different sets of NAVs, the same can be done for AIF investors.”

On the issue of upfront distribution commission, the SEBI paper notes that in some cases, these have risen to around 4-5% of the committed amount (the total money that an investor has committed to invest in a scheme over time ). When compared with other products such as MFs and PMSs that have trail commissions, the existence of large upfront commissions provides an incentive for mis-selling AIFs. This is similar to earlier examples of close-ended MF products where such commissions played a strong role in attracting new investors. “There was an exit fee of 3-4%. Therefore, chances were high that investors would not exit once they invested, thereby paying upfront commission. Similarly, higher upfront commissions are providing incentives to pursue some AIF products. up fee (see graphic),

To curb this practice, SEBI has proposed trail model of distribution commission for Category III AIFs. For the other two categories, the regulator has suggested some relaxations. To encourage investment in Category I and II funds (which in turn invest in privately owned companies), one-third of the total distribution fee may be paid upfront, with the rest on a trail basis. “Category III is relatively small. Category II which is closer 5.6 trillion size (commitments raised) is where most of the mis-selling is happening. My view is that just having a trail commission here will change the entire marketing game and usher in a level playing field,” says Randev.

dematerialization of units

Unlike mutual funds, where investors hold their units in demat form, most of the investors in AIF scheme hold units in physical form. Dematerialisation will make it easier for investors to track their AIF investments as it will form part of their Consolidated Account Statement (CAS) from the depositories, CDSL or NSDL. Most importantly, it will make it easier for the AIF units to be transferred to their next of kin in case of death of an investor.

Today, AIF units can be transferred from one investor to another only with the approval of the investment manager. With dematerialisation, this process is expected to become easier. Randev, however, highlights an important point in this context. “Dematerialisation notwithstanding, the transfer is likely to be a controlled process that will involve the fund manager.” He draws parallels to startups having demat shares. “These shares are not freely transferable and are subject to certain restrictions imposed by the founder, or subject to approval from the company whose shares are being sold. I am assuming a similar process will apply to AIF units,” says Randev .

According to Ruparelia, the logical next step for dematerialisation of AIF units would be their listing. This will provide an easy way for investors of close-ended schemes to exit the secondary market.

illiquid investment

While AIFs can invest in listed securities, a significant proportion invest in privately held companies. In certain situations, say, when an AIF is unable to exit an investment, the fund may be unable to refund the investor’s money even at the end of its tenure. The current rules give some options to AIFs to deal with illiquid investments. An AIF can extend the tenure of a scheme up to two years (one year at a time) with the approval of two-thirds of the investors. Alternatively, AIF assets can be distributed after approval from at least 75% of the investors. If no option is worked out, or if the two-year extension is completed without approval for disbursement, the AIF will have to terminate the scheme completely within one year.

SEBI has now proposed a third option – transfer of illiquid investments to a new scheme, subject to conditions including consent from 75% of investors. It has laid down several conditions relating to valuation of investments to ensure that investors are not short-changed.

However, some questions remain unanswered. What will be the fee and tax implications of the transferred investments? “Ideally investors should not be charged full management fees for these investments, but there are operational costs that will have to be incurred. This is open to discussion,” says Rohan Paranjpe, managing director, head-alternative investments, Waterfield Advisors .

Once SEBI’s latest proposals translate into regulations, AIF investors are set for a complete change in their investment experience.