On February 07, 2025, the Securities Exchange Board of India (“SEBI”), issued a consultation paper on the review of Regulation17(a) of SEBI (Alternate Investment Funds) Regulations, 2012 (“AIF Regulations”), with the objective of ease of doing business (“Consultation Paper”)[1]. The Consultation Paper invites public comments and suggestions, to be submitted at the latest by February 28, 2025. The key features of the Consultation Paper include:
I. Introduction:
The review on Regulation 17(a) of the AIF Regulations aims to address the evolving concerns regarding the shrinking universe of investment opportunities in unlisted debt securities. This shrinkage is primarily due to the recently introduced Regulation 62(A) of the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (“LODR Regulations”), which impacts the ability of entities to issue unlisted debt securities.
The core objective of this Consultation Paper is to gather public comments, suggestions, and feedback on proposals to allow Category II Alternative Investment Funds (“AIFs”) to invest in listed debt securities that have credit ratings of ‘A’ or below, in addition to their current investment in unlisted securities.
II. Background:
- Regulation 17(a) of the AIF Regulations, 2012 specifies that Category II AIFs must primarily invest in unlisted securities. According to the SEBI’s explanation in the Master Circular dated July 31, 2023, the term “primarily” refers to the fact that over 50% (fifty percent) of the fund’s investments shall be directed toward unlisted securities.
- In line with these provisions, the Consultation Paper addresses the following key regulatory shifts:
- Regulation 62(A) of the LODR Regulations, which requires all Non-Convertible Debt (“NCDs”) securities issued on or after January 01, 2024, to be listed on stock exchanges.
- The restriction on unlisted debt securities, which impacts Category II AIFs, given their regulatory obligation to invest primarily in unlisted securities.
- In line with these provisions, the Consultation Paper addresses the following key regulatory shifts:
III. Key Concerns Raised by the AIF Industry:
The AIF industry has raised concerns about the practical challenges posed by the new listing requirements of unlisted debt securities, which include:
- Shrinkage of the Universe of Unlisted Debt Securities: As a result of the amendments made to the LODR Regulations, entities with outstanding unlisted NCDs would be restricted from issuing any additional unlisted NCDs, unless one of their listed NCDs is live.
- Mandatory Listing of Outstanding Unlisted Debt Securities: Any outstanding unlisted debt securities issued on or after January 01, 2024, must be listed.
AIF representatives have expressed concerns that the restrictive nature of the new LODR Regulations could create significant challenges for these funds in maintaining their investment strategies in unlisted debt securities. This could lead to potential compliance burdens and liquidity risks. Given these changes, the available universe of investment opportunities for Category II AIFs could be significantly reduced, thereby constraining their ability to meet the current regulatory investment mandates.
IV. SEBI’s Viewpoint:
Considering the liquidity and credit risk that Category II AIFs may face, due to their closed-ended fund structure and the focus on unlisted securities, SEBI acknowledges that the shrinkage in available investment opportunities for unlisted debt securities may disrupt the ability of these funds to comply with Regulation 17(a) of the AIF Regulations. SEBI recognizes that such changes may impose unintended challenges for AIFs in fulfilling their mandate.
To address this, SEBI proposes to expand the scope of investment options for Category II AIFs, to include listed debt securities that meet specific credit rating criteria, which aligns with the funds’ risk appetite.
Further, based on internal deliberations and the recommendations of the Alternative Investment Policy Advisory Committee (AIPAC), SEBI has put forth the following proposal for public consultation:
‘Category II AIFs to invest more than 50% of their total investible funds in unlisted securities, and/or listed debt securities having credit rating ‘A’ or below, directly or through investment in units of other AIFs.’
This proposal seeks to address the possible shrinking of the universe of unlisted debt securities by allowing Category II AIFs more flexibility to invest in listed debt securities of credit rating ‘A’ or below. The rationale behind this adjustment is to ensure that Category II AIFs can continue to function within their mandate, assume credit risk, and support industries in need of funding, while still meeting their regulatory obligations, as provided in the AIF Regulations.
[1] https://www.sebi.gov.in/reports-and-statistics/reports/feb-2025/consultation-paper-on-review-of-regulation-17-a-of-sebi-aif-regulations-2012-with-the-objective-of-ease-of-doing-business_91737.html