Alternative investment funds (AIFs) are in a bind over the market regulator’s diktat to dematerialise units of funds with a corpus of ₹500 crore or more by October 31.

Less than five per cent of these funds have dematerialised their units, according to people in the know. Those that haven’t are still liasoning with investors for providing demat account details and do not have clarity on whether to freeze the account or suspend further subscriptions after the said deadline. Any such actions may commercially impact the AIFs and lead to outflows.

The industry may reach out to the Securities and Exchange Board of India (SEBI) seeking extension of timeline, grandfathering of existing investments and exemption for funds whose life is ending in the next three years.

“Dematerialisation has become a millstone around the industry’s neck,” said an official. “Given the tight timelines, only few funds with limited investors who have drawn down all their capital have been able to complete the process.”

Depositories are still rewriting the basic information they need from the AIFs, with the latest change happening last Friday, the official said: “Despite consultations, questions remain. What is needed is a fundamental rewrite of the entire operating guidelines to better reflect the nature of AIFs, as opposed to force-fitting AIFs into what works for listed securities.”

Overseas investors are worried as they will have to obtain and/or furnish their PAN number to open the demat account and link it to the bank account. At present, there is no need to obtain a PAN for holding investment in an AIF as long as the investor is KYC compliant.

Joint account holders in AIFs

Trusts and partnership firms are not permitted to open a demat account in their name as per current norms. Dematerialisation of joint account holders in AIF units could pose a challenge.

“The regulator could consider grandfathering of existing investments and exempt schemes which are still in the process of fundraising and have not exhausted the commitment period. The industry is awaiting clarity on aspects such as exemption to foreign investors to open bank accounts and the course of action for investors not providing demat accounts,” said Leelavathi Naidu, Partner, IC Universal Legal.

AIFs issue multiple classes of units to investors and will need to apply for ISINs (International Securities Identification Number) for every series, class and sub-class.

Every ISIN number that is generated is specific to a paid-up value. Every time an AIF makes a drawdown or makes a distribution, it will result in changes to the net paid-up value of an AIF unit. Drawdowns are made over several years and units are redeemed regularly over the life of the fund.

“AIFs would perpetually be in the mode of cancellation and creation of new ISIN numbers. This is an administrative nightmare and will increase the cost of compliance manifold,” said Deepak Aggarwal, Managing Partner, Bluereservoir Business Services.

Digital drive

Dematerialisation of AIF units was touted as a step towards digitisation, transparency and adequate monitoring.

“If the aim is digitisation, AIFs even today issue units and statement of accounts virtually. Further, the AIF units are privately held and are unlikely to be listed due to the very nature of operation of the AIFs,” said Aggarwal.

Investors in mutual funds have an option to hold units in demat form. Globally, private equity and venture capital investors are not mandated to hold units in demat form, said experts.