SEBI’s recent circular on investments from land bordering countries through alternative investment funds (AIFs) may add another layer of complexity in the manner in which Press Note 3 (PN3) norms are interpreted for such funds.
PN3, issued in 2020 by DPIIT, necessitated prior government approval for foreign direct investment (FDI) by entities based in any country sharing a border with India.
Legally, the PN3 framework was only applicable to Schedule 1 investments, which covers FDI in unlisted equity of Indian companies. Foreign investments into AIFs is governed by Schedule 8, which has nothing to do with PN3, said experts. While an AIF can take foreign money without any PN3 restrictions, funds so far have been reluctant to do the same because of lack of clarity on the matter.
“Press Note 3, when introduced, only applied to Schedule 1 investments under FEMA (Non-Debt Rules) and not on foreign investments in AIFs which was under Schedule 8. The law has always been unambiguous; it was only the sensitivity of the issue at hand which led to varied interpretations and conservative positions,” said Divaspati Singh, Partner, Khaitan & Co.
Aggregate investor base
The recent SEBI circular does not put any restrictions per se on investments from land bordering countries in AIFs, but only asks for added due diligence and disclosures if the aggregate investor base in an AIF is more than 50 per cent from land bordering countries and such AIFs hold more than 10 per cent in underlying portfolio companies.
“This is a clear indication that there is no concern which the regulators have if the aggregate commitments raised by an AIF from land bordering countries is less than 50 per cent,” said Singh.
Leelavathi Naidu, Partner at IC Universal Legal, believes that the SEBI circular could lead to more varied interpretation among investors and AD banks. This is because while PN3 imposes a blanket restriction on investments from land bordering countries, the circular prescribes only disclosure norms for investments below the 50 per cent threshold.
The disclosures given to SEBI could further be shared to the RBI, which may take a call on whether any restrictions are warranted, said experts.
“While due diligence requirements are applicable to both Indian and foreign owned and controlled AIFs, the latter already undergo enhanced scrutiny at the pre-investment approval stage. The circular specifically takes care of investments coming through the former,” said Mayank Arora, Director – Regulatory, Nangia Andersen India.
NSCS suggestion
The National Security Council Secretariat (NSCS) had issued a concept paper few months back outlining proposals to strengthen India’s foreign investment regulatory regime. It observed that there was scope for investments from land bordering countries through AIFs in companies beyond the permissible limit for automatic route under the FDI policy, undermining the spirit of PN3 notification.
“In its March board memorandum, SEBI highlighted that AIF structures with substantial investors from land bordering countries could undermine the spirit of PN3. While the final circular from SEBI and associated standards only impose disclosure norms on AIFs regarding land bordering countries, it could be a backdrop for further regulation as the expectation under FEMA rules seems to be a bit varied,” said Nandini Pathak, Partner, Bombay Law Chambers.
