This article analyses the recent amendment to AIF Regulations permits venture capital funds under the old VCF Regulations to migrate to Category I AIFs
In a previous article, we analysed how the Securities and Exchange Board of India (SEBI) introduced the SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2024. This amendment aims to ease the practical difficulties faced by alternative investment funds (AIFs) in cashing in their investment portfolios within the liquidation period provided under the SEBI (Alternative Investment Funds) Regulations, 2012 (AIF Regulations).In this article, we analyse SEBI’s approach to granting Venture Capital Funds (VCFs), registered under the former SEBI (Venture Capital Funds) Regulations, 1996, the flexibility to handle unliquidated investments after their schemes’ tenure expires by migrating to the AIF regime.. The VCF Regulations mandated that Venture Capital Funds (VCFs) wind up upon the expiry of their tenure as specified in their placement memorandum. SEBI did not permit extensions, even with unit holders’ consent. Additionally, the VCF Regulations lacked a clear requirement for surrendering the certificate of registration after winding up. This oversight made it challenging for SEBI to monitor the status of such VCFs effectively.
Before introducing the Third Amendment Regulations, SEBI’s consultation paper on January 12, 2024, addressed flexibility for AIFs, VCFs, and their investors in managing unliquidated investments beyond scheme tenure. As of June 30, 2023, only 49 out of 179 registered VCFs had submitted their quarterly investment reports for the quarter. The remaining VCFs appeared to have either wound up, not commenced operations, or defaulted on reporting requirements.
The Third Amendment Regulations require VCFs which have wound up all schemes or had made no investments from outstanding schemes to surrender their certificate of registration by 31 March, 2025. Failing which, SEBI would initiate appropriate action to cancel the certificate of registration. The obligation to surrender the certificate would assist SEBI in filtering out the ones who have either wound up or not commenced operations.
The SEBI aper also highlighted that not all VCFs disclose the tenure for winding up of the scheme as part of their placement memorandum and, or, are continuing in non-compliance with the VCF Regulations. In this respect, the SEBI paper provides that based on information submitted by 99 VCFs (corresponding to 102 schemes), a maturity profile analysis was undertaken. Between the years 2008 and 2022, a total of 89 VCFs were to complete their tenure but are continuing prima facie in non-compliance with the VCF Regulations. SEBI also acknowledged having received requests from VCFs and their trustees regarding difficulties faced by VCFs to fully liquidate their investment during the stipulated period.
Under SEBI’s Third Amendment Regulations, Venture Capital Funds (VCFs) can migrate to become Migrated Venture Capital Funds (MVCFs), a sub-category of Category I – Alternative Investment Funds (AIFs). This migration option is available to VCFs with:
Ongoing Schemes: Schemes whose liquidation period has not expired.
Expired Schemes: Schemes not wound-up post-expiry of the liquidation period.
MVCFs with Expired Schemes have until July 19, 2025, to liquidate their investments. For Ongoing Schemes: If the placement memorandum specifies a tenure, it remains unchanged.
If a placement memorandum lacks a specified tenure, 75% of investors (by investment value) can set the scheme’s duration before applying for migration.
VCFs choosing not to migrate will face:
Ongoing Schemes: Enhanced regulatory reporting as prescribed by SEBI.
Expired Schemes: Regulatory action for operating beyond the original liquidation period.
SEBI has on previous occasions penalised non-compliant VCFs, by imposing fines and mandating asset distribution or investor reimbursements.
The extent to which VCFs will successfully opt for migration remains uncertain, particularly since eligibility criteria require applicants to provide specified information to SEBI. For those that do migrate, liquidating investments and winding up before the deadline of July 19, 2025, is likely to be a significant challenge. This timeline deviates from the recommendation in the SEBI Paper, which has proposed a one-year period from the date of registration as an MVCF. Aligning this timeline with the one-year liquidation period available to AIFs would have been more consistent and practical. Allowing migration until July 19, 2025, while simultaneously requiring wind-up by the same date, appears inadequate and may hinder SEBI’s intent to offer flexibility. Additionally, if SEBI aims to incentivise VCFs with ongoing schemes to migrate to the AIF regime, the specific benefits for VCFs remain unclear. Enhanced reporting requirements alone may not be a strong deterrent, especially if they are merely aligned with the reporting obligations already applicable to AIFs under the AIF Regulations, as noted in the SEBI paper.
In conclusion, while the Third Amendment Regulations represent a positive step, their actual effectiveness in addressing the challenges faced by VCFs and providing tangible benefits remains to be seen.
Bharucha & Partners – Vandana Pai and Ayush Jain
