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CONCEPTPAPERONPROPOSEDALTERNATIVEINVESTMENTFUNDSREGULATIONFORPUBLICCOMMENTS

A. EXISTINGSCENARIO

At present Investment Management Regulation is limited to Mutual FundRegulation,CISRegulations,VCFRegulationandRegulationofPortfolioManagers.MutualFundsandCISareclearly intheretailsegmentandarewellregulated,theregulationofnonretailsegmentisnotonacomprehensivebasis.

B. WHYCOMPREHENSIVEREGULATIONFORPRIVATEPOOLSOFCAPITAL/

ALTERNATIVEINVESTMENTFUNDSISREQUIRED?1. SEBI(VentureCapitalFunds)RegulationswereframedbySEBIin1996toencourage

fundingofentrepreneursearlystagecompanies.However,ithasbeenfoundovertheyearsthatVCFsarebeingusedasavehicleformanyotherfundssuchas:

(i) PrivateEquity(PE)

(ii) PIPE(PrivateInvestmentinPublicEquity)

(iii) RealEstate

While investmentobjectivesof these fundsmayhavevalideconomic reasonsyetthishasresultedinaneglectoftheoriginalaimofpromotingearlystagecompaniesasenvisagedunderVCFRegulations.Secondly,becausetheVCFsarepopulatedbyPrivate Equity, PIPE and Real Estate Funds, it is not possible to give targetedconcessionstoVCFstopromotestartuporearlystagecompaniesasthere isclearpossibilitythattheadvantageswillbereapedbywellestablishedlistedcompaniesorothermainstreamplayers.AtthesametimetheinvestmentrestrictionsonVCFswhichoperateinunlistedspace,aresuchthatPEandPIPEfundsfindsitrestrictive.Further,therearesomeregulatoryconcessionsneededbyPEandPIPE fundsandwhichmaynotbeappropriateforVCFs.For instance,therearerequeststhattheyshouldbeallowedtoinvestinsecondarymarketsaswell.RecentlytherehavebeenrequestsbyvariousPEFundsregisteredasVCFtogivethemexemptionsfromTakeoverRegulationsand InsiderTradingRegulations.Tosumup,VCFsarebeingusedasanomnibusinvestmentfundwhichleavesmostoftheprivateinvestmentfundsdissatisfied.

2. RegistrationofVCF isnotmandatoryunderVCFRegulation. Notallplayers inthe

VCForPE industryare registeredwith SEBI. Theseunregisteredentitiesarenotsubject to investment restrictionswhich are applicable to registered VCFs. Thusregistered VCFs seek to enjoy similar opportunities which are exploited by

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unregisteredfunds.Toavoidhavingregulatorygapsandtohavelevelplayingfieldthereisaneedtohaveuniformnormsforsametypeoffundorindustry.

3. Thereremainsaconsiderableneedforlongtermcosteffectivefundingthatcanbe

sourcedfromdiversepartsoftheprivatesectorcapitalmarketsorprivatepoolofcapital suchasPEorPIPE fundsetc.,and that canbe translated intomeaningfulfinanceforstartups,smallandmediumbusinessandinfrastructure.Itisfeltthatamorecomprehensive legal framework isnecessary topromote thegrowthof thismarketinearnest.

4. There isaneed to recognizeAlternative InvestmentFunds (AIF)suchasPEorVC

etc., as a distinct asset class apart from promoter holdings, creditors and publicinvestors.

5. The patient source of active capital provided by PE or VC etc., plays a very

important role in the growth of the corporate sector and they bring a lot ofgovernanceandgoodqualitymoneyonthetableof investeecompany. However,recent financial difficulties inwestern countries have underlined thatmany AIFstrategies are vulnerable to some risks in relation to investors, other marketparticipantsandmarketsandmayalsoservetospreadoramplifyrisksthroughthefinancial systems. The regulatorneeds tohaveoverallpictureof risksposedbysuch funds. Therefore, it is necessary to establish a framework capable ofaddressingthoseconcerns.

6. InvestorsinVCFs,PEetc.,aresophisticatedandwellinformed.SEBIactsmoreasa

facilitatorwithminimal regulation. However,withexponentialgrowthofprivatefund industry and their systemic importance for stability of financial market,globallyprivatepoolsofcapitalarenowbeingsubjectedtoregulationofdifferentdegreebyvariousjurisdictions.SomeoftheinstanceshavebeenillustratedinparaCunderheading GlobalExperience. Thealternateasset industryneeds toberegulatedforfairandefficientfunctioningoffinancialmarket.

C. GLOBALEXPERIENCE1. Inmostofadvancedeconomies,multiplevehiclesexisttoprovidevariousavenues

forthe institutional investorsto investbasedontheir investmentneeds includinghedge funds, private equity funds, commodity funds, real estate funds,infrastructure funds, investment trusts, etc. Investors in these funds are largelyinstitutional, high net worth individuals and corporates. These investors whileentrusting their funds to the fundmanagers seeks commitment from such fundmanagerbywayskininthegame.Sucharrangementleadstoconflictasthefundmanagerisaninvestoraswellasamanager.Therefore,aframeworkisrequiredtoaddresssuchconflicts.

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2. TheG30 Report recommends that Managers of private pools of capital thatemploy substantial borrowed funds should be required to register with anappropriatenational regulator (.). The regulatorof suchmanagers shouldhaveauthority to require periodic regulatory reports and public disclosures ofappropriate information regarding the size, investment style, borrowing, andperformanceof the fundsundermanagement. TheG30 recommendations alsodealwiththemoralhazardissueidentifiedbytheFinancialStabilityForum(nowknownasFinancialStabilityBoard) in2000bystatingthatSince introductionofevenamodestsystemofregistrationandregulationcancreateafalse impressionof lower investment risk, disclosure, and suitability standards will have to bereevaluated. TheG30 also considers thatfor funds above a size judged tobepotentiallysystemicallysignificant;theregulatorshouldhaveauthoritytoestablishappropriatestandardsforcapital,liquidity,andriskmanagement.

3. TheEuropeanParliamentandCouncilhascomeoutwithaproposalforaDirective

on Alternative Investment FundManager (AIFM)1 such as Hedge Funds, PrivateEquityManagers,etc.Thesalientfeaturesofthedirectivesare:

(i) A legally binding authorization and supervisory regime for all AIFM

managingAIF in theEuropeanUnion, irrespectiveof the legaldomicileoftheAIFmanagedexceptforAIFMmanagingportfoliosofAIFwithlessthan100millionofassetsoroflessthan500million,incaseofAIFMmanagingonly AIF which are not leveraged and which do not grant investorsredemption rights during a period of five years following the date ofconstitutionofeachAIF.

(ii) To operate in the European Union, all AIFM will be required to obtain

authorizationfromthecompetentauthorityoftheirhomeMemberState.(iii) AIFMtoprovidetotheirinvestors,initiallyandonanongoingbasis,aclear

descriptionof the investmentpolicy, includingdescriptionsof the typeofassetsandtheuseofleverage;redemptionpolicyinnormalandexceptionalcircumstances; valuation, custody, administration and risk managementprocedures;andfees,chargesandexpensesassociatedwiththeinvestment.

(iv) Disclosuresandreportingtothecompetentauthorityonaregularbasis.

(v) Powerofcompetentauthority to set leverage limits forAIF toensure thestabilityandintegrityofthefinancialsystem.

1AIFM includesall fundmanagersotherthanthosecoveredundertheDirectives fortheUndertakings forCollectiveInvestmentsinTransferableSecurities(UCITS).

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(vi) AIFM to issueannualdisclosureon the investmentstrategyandobjectives

of its fundwhen acquiring control of companies and general disclosuresabout the performance of the portfolio company following acquisition ofcontrol.

(vii) AnAIFMauthorizedinitshomeMemberStatewillbeentitledtomarketits

funds to professional investors on the territory of any Member State.Member States may allow for marketing to retail investors within theirterritoryandmayapplyadditional regulatory safeguards for thispurpose.Such requirements shallnotdiscriminateaccording to thedomicileof theAIFM.

(viii) To facilitate internationalcooperation inmacroprudentialregulations, the

competent authorities of the home Member State will be required totransmitrelevantmacroprudentialdata,inasuitablyaggregatedformat,topublicauthoritiesinotherMemberStates.

Under thenew rules,AIFswillbe required toholdmore capital andmakemoredisclosuresandnonEuropeanhedgefundswillhavetogaina"passport"tooperatewithintheEU.

4. Under the Private Fund Investment Advisers Registration Act of 2010 (The Act),

enacted aspartof theDoddFrankWall StreetReform andConsumerProtectionAct, 2010 (C P Act 2010), Investment Advisers to private funds including hedgefunds andprivateequity funds are required to registerwith the SECunless theyqualify for one of the exemptions provided such as advisers to Venture CapitalFunds, smaller advisers (advising to private fundswith AUM less than USD 150million),foreignprivatefundadvisers,familyofficesetc.TheActeliminatesthesocalled private adviser exemption for advisers with fewer than 15 clients, uponwhich most private fund managers relied to avoid registration under theInvestment Advisers Act of 1940. Now all hedge fund and private equity fundadvisersthatarerequiredtoregisterwiththeSECmustdosobeforeJuly21,2011,andmustbefullycompliantwithrequirementsundertheInvestmentAdvisersActof1940.SuchadviserswillberequiredtofilereportscontainingsuchinformationasSECdeemnecessarytoprotectinvestorsorfortheassessmentofsystemicrisk.Even ifexempt fromSECregistration, (suchasVCFsorprivate fund less than150million),theywillbesubjecttorecordkeepingandreportingobligations.TheyalsoremainsubjecttoantifraudrulesandthustotheSECsenforcementauthority.TheVolckerRulemadeunderCPAct,2010prohibitsabankingentityfromacquiringorsponsoringanyhedgefundorprivateequityfund.

5. The IOSCOConsultationReportonHedgeFundsOversight(June2009),the IOSCO

TaskForcesuggeststhatprogresstowardsaconsistentandequivalentapproachof

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regulators to hedge fund managers should be a high priority. The Task Forcerecommends that regulatory oversight for hedge funds should be riskbased,focusedparticularlyon the systemically important and/orhigher riskhedge fundmanagers.

Accordingly,intheupdatedlistof38IOSCOobje