AIs, also known as qualified or professional investors, represent a category of individuals well-versed in comprehending diverse financial products and understanding the associated risks and returns. These investors are deemed well-informed due to their financial capability, allowing them to engage expert managers and advisers, thus possessing the ability to absorb potential losses. Consequently, financial products with higher risk profiles are often deemed suitable for this class of investors.
In jurisdictions where such investors are acknowledged, regulatory relaxations are extended to them, given their perceived capacity to navigate the investments landscape without extensive regulatory protection. In alignment with this, Sebi had, in August 2021, unveiled a circular detailing the implementation modalities for accrediting investors through designated accreditation agencies.
On 19 December 2023, Sebi announced pivotal steps aimed at simplifying the requirements for individuals aspiring to register as AIs. This initiative also included an extension of the certification’s validity period to a maximum of three years. Notably, the market regulator emphasized that accreditation agencies would now have the authority to grant certification based solely on applicants’ Know-Your-Customer (KYC) details and financial information. KYC registration agencies (KRAs) acting in the capacity of accreditation bodies, were granted access to the KYC database, enabling a more straightforward certification process. Despite all these reforms, the number of accredited investors in India remains abysmally low, at just 150-200.
Accreditation ecosystem
Accreditation within the investment landscape yields distinct advantages tailored to different investor categories across various investment avenues like Alternative Investment Funds (AIFs), Portfolio Management Services (PMS), and those engaging with invesment advisers.
For AIF Investors, the differentiation lies between AIs and regular investors. AIs come with a lower minimum ticket size of less than ₹1 crore. AI funds (large value investors with minimum capital commitment of ₹70 crore) enjoy the privilege of allocating a higher percentage of their assets under management (AUM) into individual companies within AIF category I & II (50%) and category III (20%), compared to regular investors who must adhere to a 25% and 10% allocation, respectively. AI funds benefit from an extended AIF life of more than 2 years, allowing for potentially longer-term investment horizons.
PMS investors also experience distinctions based on accreditation levels. Those falling under the accredited category come with a minimum ticket size below ₹50 lakh. PMS AI( investors with minimum capital of ₹10 crore) gain the advantage of placing 100% of their AUM in unlisted securities, fostering a more diversified portfolio compared to the 25% limit for regular investors with a ₹50 lakh minimum ticket size.
It seems like Sebi’s accreditation criteria inadvertently or knowingly creates a tiered system, establishing a sort of ‘super AI class’ for investors with significantly higher capital commitments. These distinctions in criteria for larger investors—like AI funds with minimum capital commitments of ₹70 crore in AIFs and PMS AI investors with ₹10 crore—grant them substantial relaxations and advantages.
Investors collaborating with investment advisers witness variations in fee structures based on their accreditation status. While fee negotiations remain bilateral for both categories, AIs may have a more flexible fee arrangement. Conversely, regular investors face a capped fee structure, limited to a maximum of 2.5% of assets under advice or ₹1.25 lakh.
Moreover, the IFSCA (Fund Management) Regulations of 2022 offer additional flexibilities specifically for AIs. These flexibilities include exemption from minimum investment thresholds in certain schemes like venture capital (VC) schemes, restricted schemes, and PMS. If a substantial majority—two-thirds—of investors in VC and restricted Schemes are AIs, the fund management entity is exempt from contributing to the scheme, offering added benefits and flexibility for accredited investment activities.
How guidelines differ
Sebi and IFSCA, the regulatory authority for GIFT City in Gujarat, have different criteria for accrediting investors. Under Sebi, individuals and Hindu undivided families (HUFs) must possess a net worth of at least ₹7.5 crore or an annual income of ₹2 crore to qualify as accredited investors. In joint holdings, one member meeting the criteria suffices, while for spouses, their combined income/net worth determines eligibility. Partnership firms are eligible if all partners meet the individual AI criteria, and trusts and corporates require a net worth of ₹50 crore or more.
IFSCA’s criteria are similar but align more with international standards in their finer details. IFSCA requires $1 million net worth or an annual income of $200,000 for individuals. Trusts and corporates must meet a $5 million net worth threshold, with specific conditions for trusts related to beneficiaries and responsible asset managers meeting AI criteria. Both Sebi and IFSCA mandate due diligence and verification processes for accreditation, with Sebi involving registration agencies for KYC purposes and IFSCA necessitating fund-conducted due diligence.
As of the latest information available, despite Sebi’s efforts, India currently has only around 150-200 accredited investors. This figure pales in comparison to the US, where the count stands at a staggering 24 million. The disparity in numbers is partly attributed to the more straightforward and inclusive process in the US, which allows participation in various private investment vehicles like hedge funds, VC and private equity (PE) only to accredited investors. Simplifying the process and aligning it more closely with international standards could potentially bolster participation in private investment opportunities, contributing to economic growth and diversification.
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Roadblocks still exist
In December 2023, Sebi allowed KRAs to access KYC documents to grant accreditation more speedily. However, financial experts believe that deeper reforms are needed.
“AIs are those who are informed and allowed to invest in riskier assets due to their better understanding of risks. Globally, only AIs have the authorization to invest in certain high-risk instruments. Sebi’s new circular eases procedural constraints, the absence of incentives for becoming an AI implies that it is unlikely to succeed in increasing their numbers in the system,” said Harsh Roongta, founder, Fee-only investment advisors.
While this reform signifies a strategic move by Sebi to promote investor participation and diversification in the Indian securities market, hurdles still exist for investors seeking to become accredited.
Firstly, the limitation of accreditation to a maximum of three years, coupled with renewal fees, might deter long-term investors. Extending this period could encourage stability and reduce administrative burdens. Secondly, Sebi relies on KRAs for accreditation, whereas other jurisdictions conduct due diligence through the vehicles/funds in which investors are placing their money.Since this would be a relatively small part of the KRA business, these agencies may not focus on speed and efficiency here. The KRA model may slow down the process of accreditation.
The criterion of ₹7.5 crore for accreditation mirrors the $1 million net worth requirement. However, aligning this criterion with India’s purchasing power parity equivalent could ensure a more contextually relevant benchmark.
In India, unlike the US, accreditation isn’t mandatory for accessing VC, PE, and hedge funds. Requiring accreditation for these asset classes could enhance investor protection and ensure a more equitable investment landscape.
Lastly, while IFSCA grants deemed accredited investor status to various institutions, Sebi mandates each to meet specific net worth criteria. Aligning these regulations could streamline processes and ensure consistency across entities.
Revisiting these aspects might refine India’s accreditation framework, potentially fostering increased participation in private investments while ensuring regulatory consistency and investor protection.