Legal Capsule by SAMVĀD: PARTNERS

SEBI RATIONALISES OVERSEAS INVESTMENT

GUIDELINES FOR AIFs AND VCFs

SEBI, by way of a circular on August 17, 2022 (“Circular”), issued new guidelines for investments by Alternative Investment Funds (“AIFs”) and Venture Capital Funds (“VCFs”) in securities of companies set up overseas.[1]  This Circular introduces significant changes to the overseas investment framework for AIFs and VCFs, including a more prescriptive application process for allocation of overseas investment limits and, most importantly, foregoing the requirement for overseas investee companies to have an Indian connection to receive investments from AIFs and VCFs.   

Background:

Under Regulation 15(1)(a) of the SEBI (Alternative Investment Funds), 2012 (“AIF Regulations”), AIFs and VCFs are allowed to make overseas investments subject to the conditions or guidelines issued periodically by the RBI and SEBI.[2]  Under the guidelines issued by SEBI dated August 9, 2007[3] and October 1, 2015[4], AIFs and VCFs are required to obtain the prior approval of SEBI for allocation of overseas investment limits, within an overall limit  for all AIFs and VCFs, which was initially US$500 million and subsequently increased to US$1,500 million in 2021 by way of a circular dated May 21, 2021[5]. In addition, AIFs and VCFs could only invest in overseas companies with an “Indian connection”, such as a company with front office operations overseas and back-office operations in India. Other important conditions for overseas investments under the prior guidelines issued by SEBI are that such overseas investments cannot exceed 25% of the investible funds of the AIFs or VCFs and that the investment must be made within 6 months of receiving SEBI approval for the investment limit.

This update discusses the principal changes to the overseas investment framework introduced by the Circular and the key takeaways from it. It is important to note that the Circular does not replace the prior guidelines issued on this topic, which continue to remain in place except to the extent modified by the Circular. In addition, AIFs/VCFs will also need to comply with the requirements of the Foreign Exchange Management Act, 1999 and the regulations thereunder, in relation to their overseas investments.

The New Guidelines:

Introduction of a detailed application form for allocation of overseas investment limit

Pursuant to the Circular, SEBI has prescribed a new format for AIFs and VCFs to apply for the allocation of overseas investment limit, which is much more detailed than the format under the prior guidelines. Under the new format, AIFs and VCFs are required to make this application for each proposed overseas investment and must furnish details of the overseas investment such as:

(i)                  particulars of the AIF/VCF and the overseas investee company, details of investment including type of investment, amount proposed to be invested and previously invested, and investible corpus of the scheme in AIF/VCF.

(ii)                details of the overseas investments made by the scheme in the past such as particulars of the investee company, amount allocated by SEBI, amount invested, if the investment has been sold, among others.

(iii)               undertakings by the trustee/board/designated partners and manager of the AIF/VCF, which are, again, more detailed than the declarations and undertakings previously required.

Doing away with the requirement of having an Indian connection

The most significant change introduced by the Circular is to forego the requirement for AIFs and VCFs to invest only in overseas companies that have an “Indian connection”.  Under the new guidelines, the only eligibility criteria for investee companies is that they must be:

(i)                 incorporated in a country that is a signatory to the International Organization of Securities Commission’s Multilateral MOU or a signatory to the bilateral MOU with SEBI; and

(ii)               not incorporated in a country identified by the Financial Action Task Force (“FATF”) as a jurisdiction having strategic anti-money laundering or combating financing of terrorism deficiencies to which counter measures apply or a jurisdiction which has not made sufficient progress in addressing the deficiencies nor has committed to an action plan developed with FATF addressing the deficiencies.

Reinvestment of divested funds

Under the prior guidelines, if an AIF who has been allocated a certain investment limit wished to apply for allocation of further investment limit, the AIF was required to make a fresh application to SEBI for such fresh allocation. The allocation of the investment limit was on a ‘first come first serve’ basis subject to availability within the overall limit of US$1500 million.  Pursuant to the Circular, SEBI has permitted AIFs and VCFs to reinvest the proceeds received from the liquidation of a previous investment.

Reporting of divestments

SEBI has introduced a requirement for AIFs and VCFs to submit the details of divestment and sale of overseas investment to SEBI in a prescribed form within 3 (Three) working days of the sale or divestments in order to enable SEBI to update the overall limit available to AIFs and VCFs for overseas investment.

In the same form, SEBI also requires AIFs and VCFs to furnish all details of the sale or divestments of overseas investments made till date within 30 (Thirty) days of the date of the Circular, i.e., on or prior to September 16, 2022.

Key Takeaways

The new guidelines are a welcome change as they provide greater flexibility for AIFs and VCFs in their overseas investment strategies.

By not restricting the scope of overseas investments to only those companies with an Indian connection, SEBI has widened the types of companies in which AIFs and VCFs can invest. This change is likely to facilitate AIFs and VCFs to invest in new-age companies such as cryptocurrency companies and Web3 companies whose Indian connection was previously not possible to be shown. Further, the new guidelines are likely to streamline the application process for overseas investment limits by allowing the proceeds from the sale of a prior investment to be reinvested in a new overseas company without the requirement for further SEBI approval, thereby also maintaining a larger pool to allocate investment limits without breaching the overall limit.

Despite these positive changes, one bone of contention in AIF and VCF circles has been, SEBI’s failure to increase the overall limit of US$1,500 million for overseas investments. SEBI, by way of a circular in May 2021, had doubled the overall limit for overseas investments from US$750 million to US$1,500 million.[1] However, even this revised limit has been considered inadequate in light of the rapid growth of the AIF industry in recent years. As the existing limit is now close to being reached, it remains to be seen if SEBI will heed calls to increase the overall limit once again. In the meantime, the ability to reinvest divestment proceeds in another overseas investee company may provide some limited breathing room for AIFs and VCFs.

Authors

APARNA RAVI

Partner

NIVEDITA NIVARGI

Partner

SHAUREE GAIKWAD

Associate

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[1] ibid

[1] https://www.sebi.gov.in/legal/circulars/aug-2022/guidelines-for-overseas-investment-by-alternative-investment-funds-aifs-venture-capital-funds-vcfs-_62020.html

[2] https://www.sebi.gov.in/legal/regulations/jul-2022/securities-and-exchange-board-of-india-alternative-investment-funds-regulations-2012-last-amended-on-july-25-2022-_61452.html

[3] https://www.sebi.gov.in/legal/circulars/aug-2007/guidelines-for-overseas-investments-by-venture-capital-funds_8308.html

[4] https://www.sebi.gov.in/legal/circulars/oct-2015/guidelines-on-overseas-investments-and-other-issues-clarifications-for-aifs-vcfs_30772.html

[5] https://www.sebi.gov.in/legal/circulars/may-2021/enhancement-of-overall-limit-for-overseas-investment-by-alternative-investment-funds-aifs-venture-capital-funds-vcfs-_50219.html