AZB & Partners is one of the most prominent law firms in India, with a leading and diverse investment funds and asset management practice. AZB advises fund managers, sponsors and financial advisors on a broad range of issues, including fund formation, capital raising, investments, carried interest structures and schemes, co-investment and feeder fund structures, key-person events and fund-related regulatory and compliance matters. The Firm also represents (Indian and international) investors on their participation in funds and investment programs which invest in the Indian region. Here Anooshree Sinha and Ganesh Rao talk to Finance Monthly about the challenges surrounding the set-up of funds in India, as well as legal regulations and trends within the sector.
How are most funds structured in India for private investors? What are the particular advantages of setting up a fund in India?
Funds and/or privately pooled investment vehicles in India are regulated by SEBI (the Indian securities regulator) primarily under the alternative investment funds regulations (AIF Regulations). Per the AIF Regulations, an alternative investment fund (AIF) can be established in the form of a trust, company, limited liability partnership or a body corporate, in accordance with the relevant Indian legislations governing such vehicles. AIFs are typically structured as trusts in India, owing to certain legal and regulatory dispensations. A trust does not have a separate legal existence and the trustee is the legal owner of the trust property who holds such property for the benefit of the beneficiaries (i.e., the investors, who have beneficial interest in the trust property). The trustee typically delegates its functions relating to investments and divestments to the investment manager under an investment management agreement.
The Indian government has, over the past year, been actively encouraging fund managers to set up funds in India and have introduced a number of measures to encourage this. India-focussed funds may be structured both domestically and/or offshore. Structuring India-focussed funds onshore may be advantageous, given that management costs are typically lower, the fund typically itself is treated as a pass-through entity and income distributed is therefore taxed in the hands of the investors. Further, given that limited partners usually mandate that their key-persons to be on the ground and near the portfolio, India domiciled funds have become prevalent. Fund managers also consider setting up domestic funds to tap capital from a pool of domestic institutional investors, including state-owned and private financial institutions and insurance companies. Exchange control laws have been liberalised to allow off-shore investments into AIFs without the requirement of governmental approvals, which lends further reason to establish funds in India. Several factors need to be considered to arrive at the optimal fund structure, including the fund’s objectives, tax implications for the fund managers (on carried interest and net management fee), regulatory and fiscal risk management for the fund and investors, target investors for capital raising, governance rights and ease of structuring portfolio investments and exits.
What are the legal requirements for setting up a fund? How does the current regulation impact the process of setting up a fund and what licenses are required?
All AIFs are required to be registered with SEBI under the appropriate category (depending on their investment objective and strategy) as specified under the AIF Regulations. This process can be carried out by filing the prescribed application form containing details about the AIF entity, sponsor, manager and supporting documents, along with the fees as prescribed in the AIF Regulations. A draft private placement memorandum, containing material information about the AIF, and relevant extracts of the constitutional documents of the AIF permitting it to carry on the activity of an AIF, are also required to be submitted. The AIF Regulations require SEBI to respond within 21 working days of filing the application. Under the AIF Regulations, before commencing any activities as an AIF, a minimum commitment of INR 200 million is required to be raised by the AIF. Under the AIF Regulations, the sponsor or manager are required to maintain a minimum continuing interest in the AIF depending on the category of registration of the AIF. In addition to the registration required with SEBI, an AIF would be required to obtain applicable tax registrations such as permanent account number, tax deduction and collection account number and service tax registrations.
How has increased regulation affected fund managers and investors? How do you assist investment managers navigate the increasingly complex regulatory landscape?
Fund managers for pooled investment vehicles in India are regulated by SEBI under the AIF Regulations and/or relevant regulations for mutual fund, real estate investment trusts or infrastructure investment trusts, and collective investment schemes, subject to the nature of the pooled investment vehicle. Additionally, SEBI also regulates management or advisory entities that provide services on an individualised basis under the relevant regulations for investment advisors, research analysts and portfolio managers, subject to the nature of the services proposed to be undertaken by such entities. Investment managers to AIFs are not required to obtain registration independently with SEBI. However, SEBI regulates such investment managers through the obligations imposed on them under the AIF Regulations such as obligations to act in a fiduciary capacity towards its investors, establish policies and procedure for mitigating conflict of interest, and comply with reporting requirements prescribed under the AIF Regulations. The increased regulations applicable to fund managers have been framed by SEBI with the objective of ensuring transparency and disclosure of information to investors.