Alternative investment funds (AIFs) are reeling under a host of compliance requirements resulting in higher cost and regulatory overlaps.

The recent diktats include a new, detailed format for private placement memorandum (PPM) audit, conducting due diligence on investors to ensure there is no circumvention of financial sector regulations and the need to clear an NISM certification examination every three years by key fund managers.

The new audit format will entail more obligations on the auditor and likely result in more inspections by the regulator, said market watchers. “This will increase the audit costs and overlaps with the practice of due diligence done by merchant bankers and other reporting requirements to SEBI. It may be good to consolidate the audit and certification requirements into one intermediary,” said Yashesh Ashar, Partner, Illume Advisory.

The AIF’s PPM has to be certified by a merchant banker and trustee even if the PPM is in SEBI prescribed format. The PPM has to be again annually updated even for changes which are not regulatorily prescribed such as updation of disciplinary actions or class of units. “The same PPM needs to be annually audited and now uploaded in an excel format. Further, there is an annual Compliance Test Report which needs to be submitted to the sponsors and trustees within 30 days from the end of financial year, notifying exceptions to compliance which includes compliances of PPM as well,” said Leelavathi Naidu, Partner, IC Universal Legal. “All these could be merged into one requirement with certain breather in timelines and eased out for better monitoring.”

Onus on managers

The new amendment mandating obligations on the manager and KMPs to conduct due diligence of the investors puts an additional layer of obligation on the manager that goes beyond the KYC mandates under KRA/CKYC or PMLA laws. “The managers will no longer be able to rely on representations from investors to their eligibility of investing in the fund and in case of any lapses the manager will become liable,” said Ashar.

Until now, an investment made by an investment vehicle into an Indian entity was reckoned as indirect foreign investment if the sponsor or the investment manager was not owned and not controlled by resident Indian citizens or was owned or controlled by persons resident outside India.

“From now on, even if the sponsor or investment manager are owned and controlled by persons resident in India, the AIF would have to ensure that the foreign investor is not using the AIF structure to circumvent FEMA,” said Vinod Joseph, Partner, ELP.

“The new norms on due diligence will impact LP comfort because they will be required to give several facts and representations to the AIF manager to comply with the law,” added Nandini Pathak, Leader - Investment Funds at Nishith Desai Associates.

To be clear, more specific guidelines may be formulated by the pilot Industry Standards Forum for AIFs, in consultation with the regulator in order to ensure that the due-diligence requirements are not open-ended or subject to interpretation.

Regulations galore

The three new diktats are in addition to scores of other regulatory requirements. For instance, AIF trustees have to prepare what is called a trustee compliance report. AIFs have to maintain about a dozen policies that include those dealing with conflict of interest, AML, insider trading, stewardship code, risk management and valuation. AIFs have to do central KYC, KRA registration, dematerialise their units and comply with SCORES and FIU-IND requirements.

A quarterly report has to be furnished to investors that includes financial information of investee companies and other material risks. A periodic reporting of information regarding the overall level of leverage employed has to be done. Immediate reporting on violation of AIF regulations, decision to suspend redemptions, systemic risks, change in key personnel and overseas limits has to be provided to the regulator.