A progressive approach to fund domicile growth in GIFT IFSC
Regulating Fund Managers

As I write this piece, my mind goes back into the many articles that I have written or the numerous conversations or representations made, to the effect that India needs to have a forward looking alternative fund regime with many fund products. I find that many of these ideas resonate in the draft fund management regulation “International Financial Services Centers Authority (Fund Management) Regulations, 2022”. The IFSCA team that drafted this regulation has tried to fill the gaps, continue the good work they are doing and setting out a road map for the future at the same time. This is forward looking for sure! It is very important to know or read the earlier regulations before this is understood. This draft regulation does not seem to be a superseding regulation; instead it seems to govern from a new angle. Therefore all stakeholders will have to trim their workflows, thought processes, settings and queries by reading both the regulations, save areas where this draft regulation has set a new method or requirement or a concept. We, as the industry participants need to be collaborative and participative, the first step being to suggest changes if any required on this draft

A major change in this draft regulation is that it seeks to regulate the fund manager instead of the fund, a very progressive, contemporary move and thus the title of the act aptly has the words “fund management”. This new regulation applies to AIF-PEVC/Long Only/Hedge funds, Mutual Funds, Family offices, Infrastructure funds, Fund Sandbox, ESG and Stressed assets et al. In a sense it is a consolidated Omnibus regulation covering a very wide spectrum.

The salient features of this draft regulation as it applies to the AIF-PEVC Industry is being discussed in this article.

This article also does not discuss the granular qualifying criteria or regulations, but instead talks about the intent, the trend and the core. It attempts to reveal a regulation as an experiential story and a narrative. Here are some of the more interesting highlights.:

• New Approach to Continuing Interest of Sponsors: Back in March 2020, I had written an article “Hidden Jewels of AIF Regulations” and proposed the concept of regulating fund managers and dropping of continuous interest for sponsors when ⅔ of the investors approve. I also advocated with the IFSCA that redomiciling managers be exempted from continuing interests. All the three suggestions have now been considered. Regulating the fund manager is far more holistic and encompassing. It also leads to better regulatory control. It is a person centered approach. There is no artificial divide between the vehicle and the driver in control. It offers light touch regulation and more accountability. In this draft regulation, the concept of registering the Fund Management Entity (FME) which is a Fund Manager Entity has been proposed. This is in line with practices in Singapore, Luxembourg, Ireland and the US.
• Eligibility Criteria for FME: The structural and networth requirements for an FME have been clearly stated in Chapter 2 and Appendix II. For a registered FME in the non retail space, the networth requirements roughly translates to INR 3.5 crore (approximately USD 466,000). Further, this networth can be maintained at consolidated parent level. Under clause 6.b, for registered and authorized managers, for the purposes of track record, hiring employees with relevant experience of five years in fund management, wealth management, broking and PMS is considered adequate.
• The Accredited Investor: There is no minimum threshold that applies to accredited investors. Thus a fund with accredited investors can start onboarding immediately on lodging the application for the scheme by a FME.
• Holdcos: Many times close groups of investors and business houses float fund schemes too. This becomes a viable option under certain circumstances. In this draft regulation, FME’s have been allowed to invest in associate entities if ⅔ of the investors approve. This is a continuation of the AIF regime. This paves way for asset holding funds of business houses to be set up
• Intermediaries for Valuation: In both parts A & B of chapter 3, the draft regulations propose an independent valuation team that are either inhouse, or a fund administrator or any other party specified by the authority. This role mandated to a fund administrator further is a very important step in ensuring proper disclosure and portfolio appraisal to investors and deepening the ecosystem. Incase of open ended funds, there are further requirements as detailed in following paragraphs.
• Chapter III A & B of the draft regulations applies to the Hedge & PEVC Industry, Open and close ended Schemes and restricted investments. The fund management entity license is divided into two primary categories in the non retail category a.k.a Alternative Investment Funds..
  
  • The first category “Authorized FME” & Venture Capital Scheme counterpart in the current regulation is category I fund and fund manager. This category would allow a fund manager entity to invest in a venture capital entity with certain restrictions. As is obvious this category has been handled with care given its risk by according it a light touch regulatory feature. A smart facility is the provision of Green Channel for this category where a FME can start the creation of the fund, conduct road shows and onboard the investors as soon as the application is lodged with the regulatory authority. The regulatory authority shall come back with comments within 21 days if any. This will give the FME a time bound licensing procedure and an instantaneous start, a very globally unique feature. If there are no comments the license shall be issued. Similar approaches have already been tried out in the IPO registration by SEBI and also the Income Tax department for scrutiny proceedings. It will immediately increase the speed to market and open gates for promoting venture capital funds to be set up quickly and motivate the startup ecosystem. This regulation provides for financing venture capital projects by having only closed ended funds financing the project. This is a patient capital approach with a time horizon of at least three years at a fund level, while providing for intre investor transfers.It also restricts the term of the fund to a maximum two years extension beyond its life with investor approval.To improve ease of doing business, it appears that Venture Capital Authorized FME’s are required to provide a NAV only once a year (Reg 24.2) to the investors . The current legislation is silent on this. If investors agree, this will reduce the cost of fund administration fee that will result in reducing the total cost of operations and improve returns. Funds are allowed to use their own template for the PPM as long as certain mandatory disclosures are made.
  • A residual non retail category also called Registered FME - Non Retail-Restricted Investments allows the FME to invest in Hedge/Listed Long Only/Private Equity/Debt /Private placement Strategy with investors who will come in as open ended or close ended in terms of exit. Thus an Asset Liability mismatch has been avoided. Such a license will also enable the FME to manage PMS portfolios, Investment Trust - Invits, multi-family offices with varying eligibility requirements. This roughly is equal to the Category III & II fund license in the current scenario.This is a wide spectrum range license. It certainly fosters mass customisation, flexibility and adaptability by a blending open or close ended approach with restricted schemes/strategies or assets. It is unique and caters to the entire life cycle of the Private Asset Manager. In addition it also permits the FME to manage Venture capital investments. Needless to say, flexibility and adaptability is the most important ability in business.It also adds to ease of doing business. A 21 day period for receiving comments by the IFSCA is provided. After 21 days it seems that there will be an automatic approval. This is a major and a unique commitment given by IFSCA when compared to other global regulators. Further where the investors in the schemes are accredited investors, the FME can onboard the investor immediately into the fund. Mega funds with 999 investors can be created. This facilitates huge funds with an economic approach to fund costs to be created. In case of open ended funds valuation of the portfolio can be done only by fund administrators or custodians or any registered persons or any person/s specified by the authority.
• Chapter V of the legislation mentions that all Scheme documents filed by an FME (that manages more than 1 $ billion in AUM) shall make positive or negative disclosures on whether sustainability based risk mitigation measures are incorporated into decision making.This is a soft part of the legislation that intends to promote Green decision making in the fund management ecosystem in IFSCA
• Chapter VI deals with other things that a registered FME ( non retail) can do by acting as a PMS manager. An FME under this can invest funds of Non Resident Individuals, NRI’s, Resident Eligible Non Resident Individuals, Resident Individuals under Liberalized Remittance Scheme.. The last two types of investors are permitted to invest offshore as allowed under the existing RBI guidelines, that apply to this category. A FME under this license shall be permitted to invest in Securities of IFSC, India and other foreign jurisdiction. However, when the engagement is of discretionary nature then such investments shall be listed , money market instruments and any other approved investments. The related regulation also specifies that investors need only be issued an online statement. This is A green sustainable progressive step.
• Part C Clause 104, of the regulation deals with structuring a Family Investment Fund. A very important thing to note is that net worth requirements for a FME is not applicable for a family fund.The investors need to be blood related and also determinate in general. Such funds can hold amongst others real estate and bullion, thus making it similar to Super T or a Wrap portfolio.
• The FME’s have been mandated to ensure that Cyber Security Risk Framework Management is in place.
• One of the suggestions that I have long made is to have the authority charge an annual fee instead of a one time fee. This is a Win Win for all the parties. It seems that is a possibility now.

Suggestions:

• Can the regulators publish the comments received under various categories in summary form? This will help forge a common view of the regulatory environment.
• Is this draft regulation in addition to or substitution of the existing AIF regulation since there seems to be no superseding clause in the regulation? Will both coexist, one regulating the fund manager and other the fund?
• It also appears grandfathering of existing managers from Category I will migrate into Authorized FME while others in the existing regulation will move into Registered FME. This needs clarification ( explanation 1 and 2 to clause 4 of Chapter 2). Additionally clarification that is required is whether the networth requirements in Schedule II of the draft regulation will be required for meeting the qualifying requirements for a grandfathering FME.
• The Green Channel approval may be renamed as “ Insta Launch ” facility
• A suggestion in this clause 4.b of Chapter II of the draft regulation would be by way of expansion to invest in listed equities in addition to private placement.This will make it clear.
• Reading from the explanation to clause 20, it seems that a lower threshold for investing in venture capital is possible for a “Registered FME”. It seems to push FME to obtain a Registered FME license. There is a use of the word “restricted schemes”
• A maximum limit to a venture capital fund has been imposed. It is not clear why? Does it mean that venture capital strategies cannot absorb more than $ 200 million in a single fund? Is it because there is a provision of Green Channel? Would it be better to ask Venture Capital funds beyond $ 200 million to onboard investors after approval, in other words no Green channel for such sizes. Today $200 million funds are considered just about size. In my own experience as a fund administrator, I have seen Venture capital funds with $ 600 million AUM in India of 2015 vintage. As an example, Accel Partners average fund size is $400 million and domiciled in Mauritius.Sequoia is even bigger domiciled in Mauritius.Therefore it is suggested that no maximum limit be placed. We are producing at least 10 unicorns every month and more capital will be needed. If funds are capped more funds will need to be created making it uneconomical due to operating costs. The ticket size for every investment ranges from 2$million to much bigger.
• The minimum size of the venture capital fund has been raised to $ 5 million. In the existing regulation this minimum size is $ 3 million. This above minimum AUM will inhibit professional first time managers who are trying it out with smaller fund sizes. Hence it is suggested that the earlier limit stands or even lowered. There are many smaller funds who may be investing in asset light intellectual property models.
• Provision for angel fund or incubation fund exists in the current legislation, but does seem to find place in the draft regulation. The reasons for this are not clear. Not clear why? The investors in angel investing generally invest small amounts and often a mix of mid level tech executives who want to spawn ventures that might not interest a venture capital fund and HNI investors . In the draft legislation there does not seem to be any category for angel, incubation and seed funds.In such a situation will the existing provisions for such investment strategies be retained in the existing legislation?
• An alternative model for small below the threshold managers would be to allow them to come under a platform fund such that they are able to take of and yet remain economical.
• By combining 22.1 with 23.3 the definition and scope of what constitutes a permissible investment for a Venture capital fund becomes much clearer. Read individually it confuses the reader as to whether it is either/ or. In other words the under 7 year business entity restriction is most appropriate in clause 22.1 and may be moved to 22.1 Clause 24(2) and Clause 27(1) of Chapter 3 Section A both talk about NAV calculations by a Venture capital fund under disclosure and computation of NAV . A suggestion might be to either cross reference it or combine under disclosure. This will lead to better ef iciencies in reading and understanding.The same will apply to Chapter 3 part B also.
• Under Sec 24(2) it seems likely that venture capital funds need to publish a NAV once a year. The word used in this section is FME. The words authorized FME may be inserted before FME since these clauses pertain to Venture Capital Strategies.
• Under clause 135, an annual audit of the FME is mandated. The words Schemes managed by the FME may be added before the acronym FME to add clarity.
• Some of the nuances like Sandbox perhaps need procedural rules to be set in order for it to be clear and ef ective.
• The regulator has committed to a maximum 21 day commenting period. The regulator must have the understanding ,infrastructure, single window approach, consolidated view of information and technology support from all stakeholders to achieve this. The regulator may want to publish the registration status at summary level between approved/, hold for want of reaction from registrants and rejected status to make sure that its ef orts are well understood by the industry.
• Further the regulator is requested to publish the observation trends periodically such that prospective registrants may take into account the observation trends and accordingly improve their checklists.
• In both sections A&B of chapter 3, it may be good to suggest the minimum number of investors that need to approve leveraging. The threshold as in other sections of the regulation may be ⅔ rd of the investors.
• Mandate of valuation has been given to fund administrators apart from other registered entities with the regulators. This puts the registered valuers on the same plane with fund administrators. Does this mean fund administrators have to register themselves with the regulator as well for valuation? Alternatively if a fund administrator is already registered as a fund administrator under the ancillary license, will they be automatically approved? Is licensing compulsory for performing the role of a fund administrator?
• Can it be clarified or defined that a fund or a scheme are analogous and mean the same?
• Although not related to this act, ef orts must be made to co opt the SEZ authorities from insisting on funds to have a separate of ice space for every fund, which is in fact an entity with the Investment manager the real person behind the fund.
• Can a Registered FME with a discretionary PMS mandate per Chapter VI invest in international listed securities? Will that need to be approved by IFSCA?
• Clause 78(3) of Chapter VI mandates that non derivative instruments may be bought or sold without effecting a Delivery vs Payment. It is not clear then how a manager will take intra day positions , square of and close the positions with a net movement. This is the very heart of high frequency trading.
• The clause 104(3) of Part C of the regulation stipulates that the family must have a minimum corpus of at least $10 million within 3 years. It is understood that this is a post setup condition.

Overall, I would conclude that the fund management regulation is a very progressive regulation that clarified, rectified certain gaps and made the whole fund domicile easy to do business with.