New rules for foreign investment by AIFs and VCFs


Foreign Investment by Alternative Investment Fund (“AIFs“) and Venture Capital Funds (“).VCFs“) are governed by the guidelines prescribed by the Securities and Exchange Board of India (“Sebi“) from time to time. With the prior approval of the Reserve Bank of India (“RBINot required for foreign investments, AIF/VCFs require SEBI’s prior approval to set foreign investment limits. The current aggregate investment limit for foreign investments by AIFs and VCFs is USD 1,500,000,000 (US Dollar One Billion Five Hundred Million), and these limits are allocated on a first-come, first-served basis. Scheme of AIF/VCF. AIF/VCF is required to invest in offshore entities within 6 (six) months from the date of approval by SEBI.

SEBI has recently issued guidelines for foreign investment by AIFs and VCFs (“New guidelines”) on August 17, 2022, which sets out the revised framework for making foreign investments by AIFs and VCFs. Prior to the issuance of the new guidelines, and subject to other prescribed restrictions, AIFs and VCFs wishing to invest in offshore investee companies were permitted to invest in offshore entities with ‘Indian connections’ (ie, offshore companies). which had back office operations in India).

With the new guidelines now effective, such pooled investment vehicles are no longer restricted by the “India connection” requirement in respect of their offshore investments.

The new guidelines are in addition to the earlier guidelines issued by SEBI on the subject (except as amended by the new guidelines).

New guidelines

  1. Eligibility Criteria for Foreign Investor Companies: According to the new guidelines, AIFs and VCFs can invest in offshore companies that:
    1. The securities market regulator is a signatory to the Securities Commission’s Multilateral Memorandum of Understanding (Appendix A Signatures) or to the Bilateral Memorandum of Understanding with SEBI whose securities market regulators are entities incorporated in the States; and
    2. Not identified by the Financial Action Task Force (“FATF“) in public statements such as: (i) a strategic anti-money laundering or combating the financing of terrorism area in which countermeasures are implemented, or (ii) a jurisdiction that has not made sufficient progress to address deficiencies or committed to an action plan developed with the FATF to address deficiencies no
  2. Revised Application Format: The new guidelines have introduced a more detailed framework for AIFs and VCFs applying to SEBI for allocation of foreign investment limits. AIFs and VCFs are required to be provided in the revised format among others Description of the foreign offshore entity, type of investment contemplated, and foreign investments made by the relevant AIF or VCF in the past.
  3. Undertaking from AIF/VCF: Further, unlike the earlier format, the revised format stipulates additional undertakings to be provided by the Trustees/Nominated Partners/Board of Directors of the applicant AIF and VCF: (a) the genuine nature of the proposed foreign investment, (b) the investment objective of the investment fund, and ( c) Compliance of proposed foreign investment with regulatory framework for foreign investment by AIFs/VCFs.
  4. Undertaking from the manager of the applicant AIF/VCF: A detailed undertaking is also required to be submitted by the manager of the applicant AIF/VCF among others the following:
    1. exercise of due diligence by the manager;
    2. the nature of the proposed instrument, which should be an equity or equity linked instrument;
    3. The proposed offshore investor company is an offshore venture capital undertaking;
    4. The proposed offshore investor entity complying with the eligibility criteria prescribed under the new guidelines;
    5. AIF/VCF not investing in joint ventures or wholly owned subsidiaries while making foreign investments;
    6. Compliance with FEMA regulations and other guidelines of RBI regarding structure involving FDI under FDI route;
    7. Non-Banking Financial Companies (“NBFCs“), where more than 50% of the funds of the AIF/VCF are contributed by a single NBFC; and
    8. The transferor entity to which the AIF/VCF sells/transfers its invested offshore stake is an entity eligible for foreign investment under the Indian Foreign Exchange Act.
  5. Reinvestment of sale proceeds: The new guidelines also clarify that sale proceeds from liquidation of its offshore investee companies by an AIF or VCF will be available for reinvestment.
  6. Sales/Disinvestment Report:
    1. The new guidelines have introduced a requirement to report to SEBI any sale/disinvestment by AIFs or VCFs. Accordingly, SEBI has prescribed a format for reporting any sale/disinvestment by AIFs or VCFs. Such reporting is required to be done by the concerned AIF or VCF by emailing the report within 3 (three) working days of disinvestment. [email protected]
    2. Further, SEBI has mandated one-time reporting by all AIFs and VCFs of their previous sale/disinvestment in offshore entities by September 16, 2022, by emailing the report. [email protected]

JSA comments

The new guidelines have certainly liberalized the previous regime which allowed AIFs and VCFs to invest only in foreign companies with ‘Indian connections’. Liberalization is coupled with additional safeguards and investment conditions that have been introduced for AIFs and VCFs willing to invest offshore.

SEBI has also reinforced its intention to increase the accountability of governing bodies and managers of AIFs and VCFs participating in offshore investments as it seeks additional undertakings from them when applying to seek limits on foreign investments.

Liberalization under the new guidelines is a step in the right direction, SEBI should eventually shift foreign investments under the automatic route. The securities regulator should also consider whether AIFs should be allowed to invest in debt instruments of foreign companies as the current regulatory framework allows AIFs to invest only in equity and equity linked instruments. Further, the RBI needs to consider raising foreign investment limits in the near term to enable Indian AIFs and VCFs to compete with foreign funds.

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