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Competition Act: Amendment to the Combination Regulations Seeks to Simplify the Procedures Relating to Combinations

The Competition Commission of India (“Commission”), with the main objective of simplifying the procedures relating to combinations provided under the Competition Act, 2002 (“Competition Act”), has recently amended the Competition Commission of India (Procedure in regard to the transaction of business relating to combinations) Regulations, 2011 (“Combination Regulations”). The Combination Regulations, which was first introduced on May 11, 2011 has been amended multiple times and the latest amendment to the same is the Competition Commission of India (Procedure in regard to the transaction of business relating to combinations) Amendment Regulations, 2018 (“Amendment Regulations”) which was notified on 9 October, 2018.

Some of the Key Amendments are:

The Amendment Regulations Provides Clarity on the Time Period of 210 Days for a Combination to come into Effect:

As per the Act, every combination shall come into effect only after 210 days have passed from the date when the notice regarding the combination has been given to the Commission or the Commission has passed an order in relation to the same, whichever is earlier[1]. The Combination Regulations provides for getting additional information, clarifications, rectification of defects, etc. if required. However, there was no clarity in relation to whether the time taken to get these details would be covered within the 210 days period. Now, as per the Amendment Regulations, it is clear that the time period for getting additional information, clarifications, rectifications of defects, etc. is not included in the 210 days period. This essentially means that the time taken for a combination to come into effect will now be longer even for deemed approval due to the additional time that may be taken for getting additional information, clarifications, rectifications, etc.

Withdrawal and Re-Filing of Notice

As per the Amendment Regulations, a new regulation 16A has been inserted which states that, any time prior to issuance of notice by the Commission to the parties to a combination under Section 29 (1) of the Act[2], the Commission, may on the request of the parties to the combination allow withdrawal and refiling of the notice. Also, in case of withdrawal and refiling, the fee already paid in respect of such notice will be adjusted against the fee payable in respect of the new notice, provided the new notice is given within 3 months from the date of withdrawal.

Modifications to the Combination

As per the Amendment Regulations, before the Commission forms an opinion under Section 29 (1) of the Act, the parties to the combination may offer modifications to the combination and the Commission may approve the proposed combination basis such modifications. The position before the amendment was that, only if the Commission considered it necessary, it may require the parties to file additional information or accept modification.

Modifications in response to the Notice issued by the Commission

As per regulation 25 (1) of the Combination Regulations, the Commission can propose appropriate modifications to a combination if it is of the opinion that such combination is likely to have adverse effect on competition but such adverse effect can be eliminated by suitable modifications. Now, a new regulation 25 (1A) is inserted whereby, along with the response to the notice issued by the Commission under Section 29 (1) of the Act, the parties to the combination also can offer modifications to address the concerns of the Commission. The Commission may approve the combination basis such modifications. In such a case, the additional time required to evaluate the modification shall be excluded from the period provided under sections 6 (2A), 29 (2) and 31 (11) of the Act.

Source:https://www.cci.gov.in/sites/default/files/whats_newdocument/Comb.%20Amend%20Regl.2018.pdf

[1] Section 6 (2A) of the Act

[2] As per Section 29 (1), where the Commission is of the prima facie opinion that a combination is likely to cause, or has caused an appreciable adverse effect on competition, it shall issue a notice to show cause to the parties to combination calling upon them to respond within 30 days of the receipt of the notice, as to why investigation in respect of such combination should not be conducted.

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Anti-dilution protection in shareholders agreement – Implementation under Indian laws

Anti-dilution protection is one term which is present in almost every investment transaction. From the perspective of the founders, especially in case of a start-up or an early stage company, it is very important to understand the implications of having such a provision in the shareholders agreement (SHA). Founders generally tend to agree to so-called “standard” terms in the SHA, when in dire need of the investment. An anti-dilution provision has to be reviewed closely in order to ensure it is not too harsh on the founders and also since the transaction documents set precedents for the subsequent round of investments. This article discusses some of the main methods of anti-dilution protection usually seen in transactions in India and some of the difficulties associated with actual implementation of such anti-dilution provisions.

What is Anti-Dilution Protection?

Before moving to anti-dilution, we need to understand the concept of dilution. Dilution is the decrease in the shareholding percentage of a shareholder in a company due to increase in the number of outstanding shares. For example, when a company receives subsequent round of investment, the shareholding percentage of the existing investors gets diluted. It is good to have the value of a company increase in subsequent rounds of funding. However, there might be situations when a company may not perform or grow as expected due to which the value of the share decreases. In such a scenario, anti-dilution protection is triggered by the existing investors to maintain their shareholding percentage in the company to a certain extent (which is explained below).

Essentially, anti-dilution protection is such protection given to the existing investors of the company when new shares are issued in a subsequent round at a price per share which is lower than the price paid by the existing investors. It is pertinent to note that anti-dilution protection is applicable only when shares are issued at a price per share which is lower than the price paid by the existing investors and not for every subsequent issue of shares. The reason being that, if shares are being offered to subsequent investors at a price per share which is higher than the price per share paid by the existing investors, even though their percentage shareholding in the company reduces, the value of the shares held by them increases.

Anti-Dilution Protection and its Variants

In India, the two commonly used forms of anti-dilution protection are: (a) Full Ratchet and (b) Broad Based Weighted Average.

Full Ratchet: Under this method, if shares are issued at a subsequent round of investment at a price per share that is lower than the price per share paid by the existing investors of the company, then the price of the shares/ conversion price of the existing investors will be revised to the price at which the new shares being issued. In such scenario, either additional shares will be issued to the existing investors for the surplus consideration after such price adjustment without the existing investors making any further payments or conversion price would be revised to the price of such shares being issued. Thus, the full-ratchet method does not consider the number of shares held by the existing investors or the number of shares being issued in the subsequent investment round, but only considers the price at which the new shares are being issued and the new price will be applied to all the shares held by the existing shareholders. Thus, the full ratchet method of anti-dilution protection is very harsh on the Company and the Founders as compared to the broad based weighted average method. Also, the shareholding percentage of the founders may get diluted to a very large extent if a full ratchet provision is implemented.

Broad Based Weighted Average: As compared to full ratchet mechanism, broad based weighted average method uses a formula which considers the number of shares issued in a subsequent round of investment and the number of shares held by the existing investors. Therefore, the broad based weighted average method is fair to the founders as well as to the investors and is adopted more frequently in investment transactions. The weighted average formula used in the transaction documents describe how the weighted average price is determined by taking into the consideration the existing price or the conversion price of the shares, number of outstanding shares prior to the new issuance, the number of shares to be issued and the purchase consideration to be received by the company with respect to such issuance.

Implications of Anti-Dilution Provision 

Pricing Guidelines under Indian Laws:

Any further issuance of shares by a Company registered in India shall adhere to various provisions of the Companies Act, 2013 (the “Act”), Foreign Exchange Management Act, 1999 including rules and regulations notified thereunder, regulations prescribed by Securities Exchange Board of India (“SEBI”) (if applicable) and Income Tax Act, 1961 (the “IT Act”).

In India, implementation of anti-dilution protection is complex considering the existing laws. For instance, shares issued to foreign investors need to be in compliance with the pricing guidelines as provided in Foreign Exchange Management (Transfer or Issue of Security by a Person Resident Outside India) Regulations, 2017 (“FDI Regulations”). As per the pricing guidelines, capital instruments which are issued or transferred to a foreign resident has to be priced as per any internationally accepted pricing methodology for valuation on an arm’s length basis duly certified by a chartered accountant or a SEBI registered merchant banker or a practicing cost accountant in case of an unlisted company.

Convertible Instruments: Additionally, in case of convertible instruments, the price/ conversion formula of the instrument should be determined upfront at the time of issue of the instrument and the price at the time of conversion should not in any case be lower than the fair value worked out, at the time of issuance of such instruments, in accordance with the FDI Regulations. Therefore, even adjusting the conversion ratio of a convertible instrument can pose complexities.

Considering aforementioned guidelines, enforcement of anti-dilution provisions and issue of shares pursuant to the same, especially to non-residents will be very difficult. Also, implementation of anti-dilution which results in issuance of new shares for no consideration, would not be allowed under the Act (which is applicable for both resident and non-resident investors).

Tax: Further, there is a complication which has to be examined under tax laws. As per section 56 (2) (x) (c) of the IT Act, when any person receives shares for a consideration which is less than the aggregate fair market value (FMV) by an amount exceeding fifty thousand rupees, the aggregate FMV of such property as exceeds such consideration is taxable as ‘income from other sources’ in the hands of the person receiving such shares.

Our thoughts:

Considering the nuances associated with the issuance of shares at a price below FMV or for no consideration, the actual implementation of anti-dilution provisions poses a lot of difficulties. Unless certain exceptions are brought in the existing laws, actual implementation could be a challenge in India, especially with respect to foreign investors.

Authors:  Mr. Paul Albert and Mr. Ashwin Bhat

Mumbai ITAT Provides Further Relief and Clarity on Valuation of Preference Shares

ACIT v Golden Line Studio Pvt. Ltd.

ITAT, Mumbai

I.T.A. No. 6146/Mum/2016 (Assessment Year 2011-12)

Judgment date: 31/8/2018

Factual Matrix of the Dispute

The case revolves around an instance of issuance of non-convertible redeemable preference shares (“RPS”) by a company called Golden Line Studio Pvt. Ltd. (the Assessee) to its holding company. The stance taken by the Assessing Officer (“AO”) in this case was that the RPS were issued at a premium of INR 490/- over the face value (INR 10/-) of the shares which seemed excessive and amenable to tax.

Brief Description AO’s Contentions

The AO in this case contended that there was no basis provided by the Assessee to justify the premium amount on the RPS, and thus had a Net Asset Valuation of the Assessee done, basis which the AO arrived at a fair market value of the RPS INR 38/- per share and contended that the share premium for the RPS also ought not have been more than INR 28/- per RPS.

The CIT(Appeals) in this case took a view that the AO was resorting to the provisions under Section 56(2)(viib) of the Income Tax Act, and since the provisions was only effective from Assesment Year 2013-14, it would not apply to the present instance.

However, the AO clarified before the CIT(A) and also before the ITAT, that the AO sought to assess the income from the share premium received by the Assessee under Section 68 of the Income Tax Act. According to the AO’s contention, under Section 68 of the Act, the Assessee is required to prove the “nature” and “source” of the receipts, otherwise income tax could be levied as unexplained cash credits. The AO implied that the excessive share premium was not accompanied with an appropriate justification as to the ‘nature’ of the receipt.

Tribunal’s Decision

The Tribunal disagreed with the contentions of the AO, and stated that the AO had misdirected himself in assessing the net asset value of the company for the RPS. The Tribunal pointed out that since Section 56(2)(viib) was not in play here, the AO did not have support of any provision of the Income Tax Act to assess the excess premium. The Bombay High Court’s decision in Vodafone India Services P Ltd v Union of India & Ors (2014) had settled that receipt by way of share capital is capital receipt, thus not assessable.

Moreover, the Tribunal observed and held that the ‘nature’ of the ‘share premium’ receipts was also not questionable because of the AO’s misdirected efforts confusing the different footings of equity and preference shares.

The ratio of this order is summarized as below:

Preference Shares and Equity Shares stand on different footing, the net asset value of a company really represents the value of Equity Shares and not the Preference Shares.”

It is so because preference shares are like quasi-debt instruments whereas equity shares are nothing but participating rights of the shareholders in the company. The valuation of equity shares is dependent on the intrinsic value of the company as they have rights in assets/funds of the company. On the other hand, valuation of quasi debt instruments like preference shares is entirely made on the basis of the returns received by the investor of such instruments.

In this case, the investor would receive a return of approx. 10% per annum, as the RPS were redeemable at a price of INR 750/- after 5 years of their issuance. Book value of the company related to the equity shares as such shares reflect the ownership over the assets of the company, but because of the different considerations involved in the quasi-debt nature of RPS, book value of assets cannot justify their pricing.

Important Takeaways

Share Premium as Capital Receipt

The ruling reinforces that share premium is a capital receipt and capital receipts should not be taxed unless a provision of the Act specifically deals with the aspect.

The Statutory Framework reflects the judicial opinion of various tribunals and courts

It is interesting to note that the holding of the Tribunal that net asset value of shares do not apply to preference shares is reflected in the valuation rules under the Income Tax Rules as well. Rule 11UA lays down the formula under the net asset value method for valuation of the fair market value of equity shares. However, for shares other than equity shares, Rule11UA(1)(c)(c) clearly states that open market valuation method will be adopted to determine the fair market value.

Relief for Early Stage Companies

The ruling definitely provides some relief to early stage companies where investments are often raised by issuance of preference shares at premium, on valuations based on DCF method rather than NAV method. However, the ruling is restricted to RPS specifically, where there is a fixed return involved. As such, the principles that could be extended for valuation of compulsorily convertible preference shares, remains to be seen yet.

Authors: Avaneesh Satyang and Sohini Mandal

Corporate Social Responsibility (CSR) Contributions in Incubators

Every company having a net worth of INR 500 crore or more, or turnover of INR 1000 crore or more or a net profit of INR  5 crore or more during the immediately preceding financial year is subject to the provisions related to Corporate Social Responsibility (“CSR”) under the Companies Act, 2013 (the “Act“). The CSR related provisions of the Act are applicable to not just companies incorporated in India, but also to a foreign company that has its branch or project office in India. For a deep dive on the general conditions attached to CSR, and how to structure your CSR activities please refer to our previous post here. In this post, we will focus on the various ways CSR can be taken by incubators.

CSR in Technology Business Incubators located within Academic Institutions:

The most straight forward way is through grants given to government recognised Technology Incubators. Under entry (ix) of Schedule VII of the Companies Act, 2013, a company is allowed to undertake activity under their CSR Policy for “contributions or funds provided to technology incubators located within academic institutions which are approved by the central govt”.

The process for obtaining approval of the Central Government as Technology Business Incubators (TBI) is captured in brief below:

  • A Host Institute (HI) which is generally an Academic/Technical/R&D Institution or other institutions with proven track record in promotion of technology-based entrepreneurship, is required to submit a proposal to National Science and Technology Entrepreneurship Development Board of the Department of Science and Technology (DST).
  • If the HI is not an academic institution, then it should be a legal entity registered in India with clear purpose of promoting research, innovation and entrepreneurial ecosystem. It is desirable to have partnership with at least one academic institute of repute.
  • Financial support for establishing a TBI is also extended to a not-for-profit legal entity registered as a trust/society/section 8 company. For-profit incubators are not given financial support by the DST.

A snapshot of the formal requirements and stages involved in constituting a TBI is provided here for ready reference[i]:

Stage Detailed requirements
Stage I – Proposal Two hard copies + soft version in MS word document in prescribed format; necessary enclosures, and consent for Terms and Conditions; must be forwarded by the Head of HI (with necessary endorsements).

Necessary enclosures that must be included:

Registration Certificate of the HI; Memorandum of Association/Bye Laws of HI; Audited Statement of Accounts for the last three years; and, Annual Reports for the last three years.

Stage II – Evaluation by NEAC and in-principal approval Evaluation of proposal is done by National Expert Advisory Committee (NEAC) on the standards innovation, incubation, and technology entrepreneurship which meets at least twice in a year. Proposal must be submitted up to one month before the meeting of NEAC.

If TBI is not-for-profit entity then, after in-principle approval they are eligible to funding from Govt. subject to these conditions:

·  Registration of TBI as not for profit society/trust or a section 8 company

·  separate bank account in TBI’s name

·  minimum 1000 sq. ft. of furnished space for hosting the TBI

·  minimum lease for land must be 15 years provided by HI

Stage III – Post Approval Conditions After the approval the following conditions must be met by the TBIs:

·  The TBI must be administered by the apex body called Governing Body.

· The Governing Body needs to be chaired by the Head of the Host Institution.

· The Governing Body of the TBI should meet every six months to review progress of TBI and provide policy guidelines for the operations of TBI.

· Each TBI would have a dedicated CEO & a compact team who works full time for TBI.

· Host institution would constitute a selection committee with a DST nominee as a member for the selection of the CEO.

· A suitable incentive mechanism (share of surplus, earning of TBI, equity stake, etc) should be evolved by the host institution for the CEO and his team. HI is free to decide on the remuneration of CEO.

·  TBI should execute appropriate agreement with incubatees. The residency period and the exit policy may also be defined clearly in the agreement.

Stage IV – Monitoring The TBI is expected to attain self-sustenance within five years of its being. However, after the approval, the Department of Science and Technology may constitute teams to monitor the progress of TBIs.

CSR in non-TBI Incubators

As per the Companies (Corporate Social Responsibility) Amendment Rules, 2018 dated 19 September, 2018[ii], provisions of the CSR Rules have been amended to widen the definition of CSR. It clarifies that the CSR Policy of the Company must include activities that are related to the ‘area or subjects specified’ in Schedule VII of the Act. Earlier, the provision only mandated activities mentioned in the CSR Policy to be related to the specific activities listed under Schedule VII of the Act. Through this amendment, the MCA has provided more freedom to companies in choosing their preferred CSR engagements under the CSR Policy.

Pursuant to the amendment, funding of activities by incubators not being TBIs approved by Central Govt. is now possible. However, the same should be within the scope of the CSR Rules.

Other important considerations for CSR by foreign companies:

Compliance with Foreign Contribution Regulation Act, 2010 (FCRA):

Under the FCRA, approval and license from the Ministry of Home Affairs (MHA) is required for accepting and utilizing grants under CSR from foreign companies (which qualifies as foreign contribution) to non-profit entities. Thus, foreign companies undertaking CSR will have to ensure that any third-party entities that it seeks to engage for its CSR activities have an FCRA license (For our post explaining the issue, read here).

Earlier Indian companies with majority foreign stake holding were also considered as a ‘foreign source’. However, after amendments made by the Finance Act, 2016, contributions made by companies whose foreign shareholding are within the limits specified under the FDI regulations are not be considered as ‘foreign source’. Thus, Indian subsidiaries of foreign companies do not fall within the ambit of FCRA compliances for their CSR activities.

[i] Detailed procedure may be referred to, available at:   http://www.nstedb.com/institutional/Approved%20Revised_guidelines_of_TBI.pdf

[ii] Available at:

 http://www.mca.gov.in/Ministry/pdf/CompaniesCSRPolicyAmendRules2018_19092018.pdf

Author: Avaneesh Satyang

Regulatory Update: Ministry of Electronics and Information Technology- Information Technology (Information Security Practices and Procedures for Protected System) Rules, 2018.

The Ministry of Electronics and Information Technology (MEITY) vide notification dated 22nd May, 2018 has notified the Information Technology (Information Security Practices and Procedures for Protected System) Rules, 2018 (“Rules”) which shall come into force on the date of publication in the Official Gazette.

The Rules detail the responsibilities to be met by various organisations which have a protected system. “Protected System” means any computer, computer system or computer network of any organisations notified under section 70 of the Act, in the official gazette by appropriate Government.

Constitution of Information Security Steering Committee

The Rules mandate that an organisation having a Protected System shall constitute an Information Security Steering Committee (ISSC) whose chairman shall be the Chief Executive Officer/ Managing Director/ Secretary of the organisation (Rule 3 (1) (a)). The composition of the ISSC as mentioned Rule 3 (1) (b) shall be as follows:

  • IT Head or equivalent;
  • Chief Information Security Officer (CISO);
  • Financial Advisor or equivalent;
  • Representative of National Critical Information Infrastructure Protection Centre (NCIIPC);
  • Any other expert(s) to be nominated by the organisation.

The ISSC shall be the apex body and its responsibilities (as mentioned under Rule 3(2)) shall be as follows:

  • All the information security policies of a Protected System has to be approved by the ISSC.
  • Any significant change in the network configuration which has an impact on the Protected System shall be approved by ISSC.
  • It is mandatory that each significant change in the application(s) of the Protected System shall be approved by ISSC.
  • A mechanism has to be established which ensures timely communication of the cyber incident(s) related to Protected System to the ISSC.
  • Protected System shall be validated for assessment after every 2 (two) years.

The Rules also lay down certain roles and responsibilities for the organisations having a Protected System (as mentioned under Rule 3(3)). Some of the key responsibilities are as follows:

  • Nominate an officer as CISO whose roles and responsibilities shall be as per the latest Guidelines for Protection of Critical Information Infrastructure (“Guidelines”) and “Roles and Responsibilities of CISOs of Critical Sectors in India” released by the (NCIIPC);
  • Plan, establish, implement, operate, monitor, review, maintain and continually improve Information Security Management System (ISMS) of its system as per the latest Guidelines released by the NCIIPC or an industry accepted standard duly approved by the said NCIIPC;
  • Ensure that the network architecture of Protected System shall be documented;
  • The same shall be reviewed at least once a year, or whenever required, or according to the (ISMS);
  • Plan, develop, maintain and review the documents of inventory of hardware and software related to Protected System;
  • Ensure that the vulnerability/threat/risk (V/T/R) analysis for the cyber security architecture of Protected System shall be carried out at least once a year. Further the (V/T/R) analysis shall be initiated whenever there is significant change or upgrade in the system, by intimation of the same to ISSC;
  • Plan, establish, implement, operate, monitor, review, and continually improve Cyber Crisis Management Plan (CCMP) in close coordination with NCIIPC;
  • Ensure conduct of internal and external Information Security audits periodically.
  • Establish a Cyber Security Operation Center (C-SOC) using such tools and technologies to implement preventive, detective and corrective controls to secure against advanced and emerging cyber threats.
  • The records of unauthorised access, unusual and malicious activity, if any, shall be documented;
  • Establish a Network Operation Center (NOC) using tools and techniques to manage control and monitor the network(s) of Protected System.
  • Plan, develop, maintain and review the process of taking regular backup of logs of networking devices, perimeter devices, etc. and services supporting “Protected System” and the logs shall be handled as per the ISMS as suggested.

The Rules also lay down responsibilities of the CISO towards NCIIPC (As mentioned under Rule 4). They are as follows:

  • CISO shall maintain regular contact with the NCIIPC and will be responsible for implementing the security measures.
  • CISO shall share inform the NCIIPC, whenever there is any change, and incorporate the inputs/feedbacks suggested by the said (NCIIPC)- with regard to details of Critical Information Infrastructure (CII), details of ISSC, network architecture of the Protected System., etc.
  • CISO shall establish a process, in consultation with the NCIIPC, for sharing of logs of “Protected System” with NCIIPC to help detect anomalies and generate threat intelligence on real time basis.
  • CISO shall also establish a process of sharing documented records of Cyber Security Operation Center (related to unauthorised access, unusual and malicious activity) of Protected System with NCIIPC to facilitate issue of guidelines, advisories and vulnerability, audit notes etc. relating to Protected System.
  • CISO shall establish a process in consultation with NCIIPC, for timely communication of cyber incident(s) on Protected System to the said NCIIPC.

Available at:

http://meity.gov.in/writereaddata/files/NCIIPC-Rules-notification.pdf

Post Formation Compliance Requirements for Alternative Investment Funds (AIFs)

AIFs are privately pooled investment funds in India, typically set up in the form of a trust or a company or a body corporate or a Limited Liability Partnership (LLP). Please see our previous post to read more on a brief introduction to AIFs.

As per the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 (the ‘AIF Regulations’), an AIF can be registered in one of the following three categories:

Categories Particulars Type Tenure
Category I Mainly invests in start-ups, SME’s or any other sector which Govt. considers economically and socially viable. Close Ended Determined at the time of application which shall be minimum 3 years.
Category II Private equity funds or debt funds for which no specific incentives or concessions are given by the government or any other Regulator Close Ended Determined at the time of application which shall be minimum 3 years.
Category III Hedge funds or funds which trade with a view to making short-term returns or such other funds which are open-ended and for which no specific incentives or concessions are given by the government or any other Regulator. Open Ended or Close Ended No specific tenure

 

Reporting Mechanism

For proper adoption of the AIF regulations, 2012 the Securities and Exchange Board of India has issued the Operational, Prudential and Reporting Norms for Alternative Investment Funds vide its Circular No. CIR/IMD/DF/10/2013 dated 29 July 2013. Furthermore, in order to ensure conformity with the operational guidelines, the SEBI introduced the “Guidelines on disclosures, reporting and clarifications under AIF Regulations” vide its Circular No. CIR/IMD/DF/14/2014 dated 19 June 2014.

Following are the reporting obligations for all categories of AIF:

  1. As per Regulation 28 of the AIF Regulations, periodical reports (with respect to funds raised, net investments by the AIF, leverage undertaken if any, exposure, categories of investor, etc) shall be submitted by all AIFs to the SEBI with respect to their activity.
  2. Category I and II AIFs and Category III AIFs that do not undertake leverage shall submit a quarterly report with the SEBI as per the Annexure I.
  3. Category III AIFs undertaking leverage shall submit a monthly report with the SEBI as per Annexure II.
  4. As per the Circular No. CIRCULARSEBI/HO/IMD/DF1/CIR/P/2017/87 dated 31 July 2017 the aforementioned reports shall be submitted through the SEBI Intermediary Portal at https://siportal.sebi.gov.in
  5. Such reports shall be submitted within 7 calendar days from the end of the quarter/end of the month as the case maybe.

Further, all AIFs have to comply with the requirements of preparation of a Compliance Test Report (CTR) as laid down below:

  1. At end of financial year, the manager of an AIF shall prepare a compliance test report on compliance (an exhaustive reporting of the AIF’s activities) with AIF Regulations and circulars issued thereunder in the format as specified.
  2. In case of the AIF is a trust, the CTR shall be submitted to the trustee and sponsor within 30 days from the end of the financial year. In the case of other AIFs, the CTR shall be submitted to the sponsor within 30 days from the end of the financial year.
  3. In case of any observations/comments on the CTR, the trustee/sponsor shall intimate the same to the manager within 30 days from the receipt of the CTR. Within 15 days from the date of receipt of such observations/comments, the manager shall make necessary changes in the CTR, as may be required, and submit its reply to the trustee/sponsor.
  4. In case any violation of AIF Regulations or circulars issued thereunder is observed by the trustee/sponsor, the same shall be intimated to SEBI as soon as possible.

Apart from the aforementioned reporting requirements, Category III AIFs have to comply with certain other reporting and compliance norms.

Risk Management and Compliance requirements for Category III AIFs employing leverage

Category III AIFs that employ leverage have to comply with the following risk management requirements:

  1. The AIF should have a comprehensive risk management framework along with an independent risk management function which shall be appropriate to the size, complexity and risk profile of the fund.
  2. Presence of a strong and independent compliance function appropriate to the size, complexity and risk profile of the fund. The same shall be supported by sound and controlled operations and infrastructure, adequate resources and checks and balances in operations.
  3. Appropriate records of the trades/transactions performed shall be maintained and such information should be available to SEBI, whenever sought.
  4. Full disclosure and transparency about conflicts of interest should be made to the investors. Further, how such conflicts are managed from time to time shall also be disclosed in accordance with Regulation 21 of the AIF Regulations and any other guidelines as may be specified by SEBI from time to time. The details of such conflicts shall be disclosed to the investors in the placement memorandum and by separate correspondences as and when such conflicts arise. Such information shall also be disclosed to SEBI as and when required by SEBI.

Redemption Norms for open-ended Category III AIFs

  1. The Manager of these AIFs should ensure that there is a sufficient degree of liquidity of the scheme/ fund so that it meets redemption obligations and other liabilities.
  2. The Manager shall establish, implement and maintain a liquidity management policy and process so that the liquidity of the various underlying assets is consistent with the overall liquidity profile of the fund/scheme while making any investment.
  3. The Manager shall disclose any possibility of suspension of redemptions to the investors in the placement memorandum
  4. Suspension of redemptions shall be justified by the Manager only if such suspension is in the best interest of the investors of the AIF or if such suspension is required under the AIF regulations or SEBI
  5. Operational capability shall be built by the Managers of such AIF so that redemption can be suspended in an efficient manner. No new subscriptions shall be accepted during the suspension of redemptions.
  6. The Manager shall communicate to SEBI the decision of suspension along with the reason for such suspension and the same shall be appropriately documented.
  7. The Manager shall review the suspension regularly and take all necessary steps to resume operations in the best interest of the investors.
  8. It shall be the duty of the Manager to keep the SEBI informed about the actions undertaken throughout the suspension and also the decision to resume normal operations.

Category III AIFs undertaking leverage shall have to comply with the prudential requirements (calculation of leverage, total exposure, etc) as laid down in the Circular.

Compliance requirements in case of breach of leverage limits for Category III AIFs

Category III AIFs shall ensure that adequate systems are in place to monitor their exposure so that the leverage does not exceed at any time beyond the prescribed limits. The AIF shall report to the custodian on a daily basis the amount of leverage at the end of the day (based on closing prices) and whether there has been any breach of limit. Such reporting shall be done by the end of the next working day (as per Circular No. CIR/IMD/DF/14/2014 dated 19 June 2014).

Reporting requirements in case of breach of limit:

  1. AIF shall send a report to the custodian in case of any breach of limit. The custodian shall report to SEBI providing a name of the fund, the extent of breach and reasons for the same before 10 A.M. on the next working day.
  2. A report shall be sent to all the clients stating that there has been a breach in the limit along with reason, before 10 A.M. of the next working day
  3. The AIF shall square off the excess exposure and bring back the leverage within the prescribed limit by end of next working day. However, an action may be taken by SEBI against the AIF under SEBI (Alternative Investment Funds) Regulations, 2012 or the SEBI Act.
  4. A confirmation of squaring off of the excess exposure shall be sent to SEBI by the custodian by end of the day on which the exposure was squared off.

Author: Ms. Alivia Das

Regulatory Update: SEBI- Investment by Foreign Portfolio Investors (FPI) through primary market issuances

SEBI (Foreign Portfolio investors) Regulations, 2014 (“Regulation”) mandated that the purchase of equity shares of each company by a single portfolio investor or an investor group shall be below 10 (ten) percent of the total issued capital of the company. Further the Regulation required that in case the ultimate beneficial owner(s) invest through multiple entities, such entities shall be treated as part of the same investor group and the investment limits of all the entities shall be clubbed as applicable to a single portfolio investment.

SEBI through this circular IMD/FPIC/CIR/P/2018/114 dated 13 July 2018 has ensured compliance of the above, at the time of allotment during primary market issuances. The Registrar and Transfer Agents (RTAs) shall:

  • Use Permanent Account Number (PAN) issued by Income Tax Department of India for checking compliance for a single portfolio investor; and
  • Obtain the validation from the depositories for the foreign portfolio investor who have invested in the particular primary market issuance to ensure there is no breach of the investment limit.

Further the circular also mandates for the depositories to put in place the necessary systems for sharing information with RTAs within the timelines for issue procedure, as prescribed by SEBI.

(Source: https://www.sebi.gov.in/legal/circulars/jul-2018/investment-by-foreign-portfolio-investors-fpi-through-primary-market-issuances_39539.html )