We analyse the new framework by SEBI for Alternative Investments Funds, in a two-part primer on the amendments. 

In India, schemes launched by alternative investment funds (AIFs) under the Securities and Exchange Board of India (SEBI) (Alternative Investment Funds) Regulations, 2012 (AIF Regulations) have a fixed tenure of operation. Under Regulation 13(6) of the AIF Regulations, these schemes were required to be wound up within 12 months of the expiry of that tenure (Liquidation Period).

To ease the practical difficulties faced by AIFs in liquidating their investment portfolios within the specified tenure, SEBI introduced a Liquidation Framework in June 2023 (Liquidation Framework). This Liquidation Framework permitted AIFs to transfer any investments which could not be liquidated prior to expiry of the tenure of the scheme (Original Scheme) to a separate scheme (Liquidation Scheme).

While the Liquidation Framework was formed to enable AIFs to liquidate their holdings more efficiently, it created a host of issues. AIFs had to expend time and resources in establishing and managing a Liquidation Scheme, the cost of which was inevitably passed down to investors. The Liquidation Scheme also led to adverse tax consequences because of the transfer of assets from the Original Scheme to the Liquidation Scheme. Additionally, investors were taxed on the replacement of units of the Original Scheme with units of the Liquidation Scheme.

In order to alleviate these issues and to address industry concerns, SEBI released a Consultation Paper (Consultation Paper) proposing an alternative to the Liquidation Scheme. Instead of transferring assets to a Liquidation Scheme, the Original Scheme itself could enter into a dissolution process to deal with unliquidated assets.  Subsequently, in April 2024, SEBI amended the AIF Regulations through the SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2024 along with a circular conferring flexibility on AIFs to deal with unliquidated investments. The amendments effectively replaced the previous Liquidation Framework, also:

  1. Allowing for a dissolution period following the expiry of the Liquidation Period of an AIF (Dissolution Period) during which the AIF must liquidate its unliquidated investments without launching a separate Liquidation Scheme     
  2. Mandated in-specie distribution of an AIF’s assets when the AIF does not enter into a Dissolution Period    

The option to launch a Liquidation Scheme is now no longer available to AIFs.

Conditions for entering into the Dissolution Period

An AIF may enter into a Dissolution Period if:

  1. It has obtained the consent of 75% of its investors by value of investment    
  2. It has disclosed all relevant information regarding the Dissolution Period (tenure, quantum of unliquidated investments, etc.) to its investors prior to obtaining their consent    
  3. Prior to the expiry of the Liquidation Period, it has informed SEBI by way of an Information Memorandum that at least 75% of investors have approved the decision to enter into the Dissolution Period.     
  4. It has arranged for bids for a minimum of 25% of the total unliquidated value of its investments. This amount will serve as an exit option for investors dissenting of the Dissolution Period. In the event that the AIF does not obtain bids for 25% of the unliquidated value of its investments, it may still enter into a Dissolution Period, subject to consent of the unitholders having been obtained in accordance with paragraph 1 above.

Liquidation Timeline and Structure

The amended AIF Regulations contemplate that subject to the AIF meeting the prerequisites stated above, the Dissolution Period shall commence immediately following the end of the Liquidation Period. The Dissolution Period cannot be longer than the tenure, along with extensions, of the Original Scheme. If at the end of the Dissolution Period the Original Scheme has failed to liquidate all its assets, the remaining assets will be distributed in-specie to the investors of the AIF. 

In theory, the Dissolution Period provides a systematic framework for addressing unliquidated assets of an AIF, without the downsides of the previous Liquidation Framework.

Relief to AIFs with expired Liquidation Period

In order to extend the flexibility to all AIFs with active schemes, AIFs whose Liquidation Period expired on or before 24 July 2024 have also been permitted to avail of the Dissolution Period. Subject to there being no pending investor complaints regarding non-receipt of funds or securities, these AIFs may extend their Liquidation Period up to 24 April 2025. If an AIF has pending investor complaints, it can avail of the extended Liquidation Period only post resolving all complaints, and in any event, only up to 24 April 2025.

Benchmarking Performance of AIF Managers

For evaluation of the AIF manager’s performance during the Dissolution Period and to enable reporting to performance benchmarking agencies, the amended AIF Regulations provide that the valuation of the unliquidated investments of a scheme shall be calculated:

  1. based on the bid value, if the AIF has obtained a bid for 25% of the unliquidated investments
  2. INR 1, if the AIF has failed to obtain a bid for 25% of the unliquidated investments. This creates an incentive for AIFs and their managers to liquidate the AIFs efficiently.

Concluding Comments

The amended AIF Regulations and the proposed framework for dissolution provide a more viable, simplified mechanism for liquidation of AIFs’ investments and better protects the interests of investors.

The ability for AIFs to internally manage their own liquidation process is in line with global practices, and is, therefore, likely to provide additional comfort for foreign investors. However, it remains to be seen whether the new framework will result in a delay of the proper recognition and disclosure of true asset quality, asset liquidity, and performance of the AIF, as contemplated by SEBI in its consultation paper.

Bharucha & Partners – Vandana Pai and Priankita Das