SEBI’s new rules for Investment Committee have put AIF managers in a quandary
The formation and function of the Investment Committee (IC) by the investment manager has always been a very closed affair, depending on the preferences of the investment manager. The members of the IC, being industry veterans or experts, usually act as a sounding board to the investment manager in their investment / divestment decisions. Thus, the IC always played a recommendatory or advisory role, and the final decisions rested with the investment manager who is responsible under the investment management under the PPM and the agreement with the contributors. The SEBI amendment makes the investment manager responsible for the decisions for investments/divestments, while also making the members of the IC, if the IC is constituted, equally responsible for those decisions. This will substantially change the role and the level of involvement of the members of the IC in the new AIFs
The members of the IC, being equally responsible, will now ask for a substantial representation in the decision-making process in the AIFs. Though AIF Regulations are silent on the delegation of the investment management activity by the investment manager, the amendments result in the sharing of such responsibility, which in turn tantamount to sharing/delegation of decision-making authority of the investment manager.
The investment managers may be required to tweak the decision-making process by forming a joint committee of the members of the IC and the representatives of the investment manager who could jointly vote on the investment decisions. This joint committee could be held responsible for all the investment/divestment decisions going forward basis. The join committee would also be named in the PPM as required by the amendments.
Certainly, the SEBI has envisaged that the joint responsibility for the decision making would be in the interest of the investors who, at times, invest monies in AIFs launched by new investment managers having IC members with strong credentials. Also, it should ensure that the individuals choosing to be members of the IC of a particular AIF have done the required due diligence on the investment strategy/thesis and the competence of the investment managers. Also, with this added onus, the members of the IC would have to ensure that they have adequately satisfied themselves with the compliances under AIF Regulations.
The amendment could also influence the discussions between the investment manager and potential anchor investors. The anchor investors could now bargain for a representation on the IC, increasing their influence on the investment strategy and the decisions of the investment manager. Though anchor investors have been securing protective rights towards their interest in the AIFs, the new potential representation on the IC and eventually, on the joint committee, will provide them the ability to influence the decision-making process of the investment manager. This conflict of interest may require the approval of the other investors.
Lastly, there comes a question of how the existence of individuals who are not resident Indian citizens (‘non-resident members’) on the IC impact the status of the AIF under the FDI Policy. As per the FDI Policy, an AIF, which is managed by an investment manager which is in-turn ‘owned’ and ‘controlled’ by resident Indian citizens, is treated as a domestic AIF. Investment by such AIF is not treated as foreign investment irrespective of the fact that foreign investors have committed monies in such AIFs. Thus, such domestic AIFs are not required to adhere to the FDI Policy at the time of making investment/divestments. As per the FDI Policy, ‘control’ shall mean the right to appoint the majority of the directors or to control the management or policy decisions, including by virtue of their shareholding or management rights or shareholders agreement or voting agreement.
Considering that the members of the IC will now be able to influence policy as well as investment/divestment decisions of the AIFs, the existence of non-resident members on the IC / joint committee raises doubts on the residential status of the domestic AIFs. The SEBI has rightfully referred to matter to the RBI for clarification in this regard. However, a minority representation of the non-resident members on the IC / joint committee should not impact the residential status of the AIFs, subject to any affirmative or veto rights given to such members.
To sum up, the new amendment thus makes a strategic shift in the decision-making process of the investment managers of the AIFs in India. In the last six months, SEBI has come out with the number to measure to streamline the governance and compliance of the AIF by introducing the standardization and audits of PPMs, benchmarking of performance of AIFs, and additional qualifications for the team of the investment manager. However, with the current amendment, the SEBI has stepped up the ante on the governance for AIFs, the requirement of which is debatable. The composition of the IC/joint committee will have to be evaluated in light of the aspects discussed above for new AIFs.
The above article is written by CA Yashesh Ashar, Partner with Sudit K. Parekh & Co. The views expressed our personal.