SEBI Overhauls AIF Rules: New Framework for Liquidation and Residual Funds

The Securities and Exchange Board of India (SEBI) has introduced significant regulatory shifts to provide Alternative Investment Funds (AIFs) with greater operational flexibility during the winding-up process. By allowing funds to retain liquidation proceeds beyond their official tenure, the regulator aims to address unforeseen legal and operational hurdles that often arise during fund dissolution.

Flexibility to Retain Proceeds Amidst Liabilities

Under the new guidelines, AIFs and their individual schemes are no longer strictly bound to distribute all capital immediately upon reaching the end of their permissible fund life. SEBI has outlined three specific scenarios where funds may retain liquidation proceeds:

  1. Litigation and Regulatory Demands: If a fund receives notices from tax authorities, law enforcement, courts, or regulators, it can hold funds to cover potential liabilities, even if those liabilities have not yet fully crystallised.
  2. Investor Consent for Anticipated Liabilities: A fund manager can retain money to cover expected liabilities if they obtain formal consent from at least 75 per cent of investors by value. In such cases, managers must disclose the exact amount to be retained and the estimated duration.
  3. Residual Operational Expenses: Funds may hold capital to meet winding-up costs, though this retention is strictly capped at a maximum of three years from the end of the fund's permissible life.

To ensure standardization, SEBI has directed the Standard Setting Forum for AIFs (SFA) to define which specific operational expense heads are eligible for this retention.

Introduction of the 'Inoperative Fund' Status

To streamline the management of wound-up funds that still hold residual cash or are tied up in ongoing legal battles, SEBI has introduced the 'Inoperative Fund' framework. An AIF can apply for this status if it has liquidated all its investments but still holds retained proceeds or remains registered due to pending litigation.

While this status offers relief, it comes with strict limitations to protect the integrity of the market. Inoperative Funds are strictly prohibited from:

Any retained money within an Inoperative Fund must only be invested in instruments that are permitted under the existing AIF Regulations.

Compliance and Reporting Obligations

To prevent the misuse of this flexibility, SEBI has balanced the new permissions with rigorous reporting mandates. AIFs that retain funds, as well as those classified as Inoperative Funds, must file an annual report detailing the retained money and outstanding liabilities. This report must be submitted to both SEBI and the investors within 30 days of the end of each financial year.

Recognizing the administrative burden, SEBI has exempted Inoperative Funds from several heavy compliance requirements, such as quarterly and annual activity reports, performance benchmarking disclosures, and certain audit requirements for Private Placement Memorandum (PPM) terms. These new rules take effect immediately and also extend to Venture Capital Funds registered under the 1996 regulations.

Key Takeaways