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Framework for Category I and II Alternative Investment Funds (AIFs) to create encumbrance on their holding of equity of investee companies

Securities Exchange Board of India (SEBI) circular issued on April 25, 2024, introduces amendments to the SEBI (Alternative Investment Funds) Regulations, 2012, aimed at providing flexibility to Category I and II AIFs (Alternative Investment Funds) regarding the creation of encumbrance on their equity holdings in investee companies. The amendments are intended to facilitate the raising of debt by such investee companies. Here's a summary of the key points:

1.        Purpose of the Amendment: The amendment allows Category I and Category II AIFs to create encumbrance on the equity of investee companies engaged in infrastructure projects listed in the Harmonised Master List of Infrastructure issued by the Central Government. This is specifically for the purpose of borrowing by the investee company.


2.        Conditions for Creation of Encumbrance:

a. Existing schemes of Category I or Category II AIFs, which have not onboarded investors prior to April 25, 2024, may create encumbrance on equity holdings of investee companies, subject to explicit disclosure and disclosure of associated risks in their Private Placement Memorandums (PPMs).

b. Encumbrances already created by such schemes prior to April 25, 2024, may continue if explicitly disclosed in the PPM.

c. Encumbrances created without explicit disclosure in the PPM require consent from all investors by October 24, 2024. If consent is not obtained, the encumbrances must be removed by January 24, 2025.


3.        Utilization of Borrowings: Category I or Category II AIFs must ensure that borrowings made by the investee company against the encumbered equity are utilized only for the development, operation, or management of the investee company as specified. Further the limitation on usage of borrowing shall be included as one of the terms of the investment agreement entered between the AIF and the investee company.


4.        Duration of Encumbrance: The duration of encumbrance should not exceed the residual tenure of the Category I or Category II AIF scheme.


5.        Compliance: Category I or Category II AIFs with more than 50% foreign investment or with foreign sponsors/managers must comply with RBI Master Direction on Foreign Investments in India. Category I or Category II AIFs must ensure that in case of default by the borrower investee company, the fund or its investors are not liable beyond the encumbered equity.


6.        Restrictions:

a. AIFs cannot extend any form of guarantee for investee companies.

b. Encumbrances cannot be created on investments in foreign investee companies.


7.        Implementation Standards: The Standard Setting Forum for AIFs (SFA), in consultation with SEBI, will formulate implementation standards to ensure that encumbrances created are utilized only for facilitating debt raising in the infrastructure sector.


8.        Compliance Test Report: Trustees/sponsors of AIFs must ensure that compliance with this circular is included in the Compliance Test Report prepared by the manager.

The circular is effective immediately upon issuance.

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