Operational, prudential and reporting norms for Alternative Investment Funds. Executive summary

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1 1 August 2013 EY Regulatory Alert Operational, prudential and reporting norms for Alternative Investment Funds Executive summary This Regulatory Alert summarizes the operational, prudential and reporting norms issued by the Securities and Exchange Board of India in respect of Alternative Investment Funds.

2 Background The Securities and Exchange Board of India (SEBI) on 21 May 2012 notified the SEBI (Alternative Investment Funds) Regulations, 2012 (AIF Regulations). Under the AIF Regulations, Category III AIFs are required to comply with such directions as regards operational standards, conduct of business rules, prudential requirements, restrictions on redemption and conflict of interest as may be specified by SEBI. Further, under the AIF Regulations, SEBI is empowered to prescribe the reporting requirements to monitor compliance by all AIFs. Pursuant to the above powers under the AIF Regulations, SEBI issued a circular on 29 July 2013 (Circular) prescribing the operational, prudential and reporting requirements for AIFs. The Circular encapsulates the following norms for AIFs: Norms Reporting requirements Risk management and compliance Prudential requirements as regards leverage Redemption norms Applicability All AIFs Category III AIFs employing leverage Open ended Category III AIFs This alert summarises the key aspects of the circular issued by SEBI. Reporting requirements Reports are to be submitted by all categories of the AIFs through the online reporting system to be provided by SEBI. the following due dates and within the stated frequency: Category of AIF Category I AIF Category II AIF Category III AIF (which do not undertake leverage) Category IIII AIF (with leverage) Frequency of submission of reports Quarterly Monthly Risk management and compliance Due dates 7 th of the following the end of quarter 7 th of the following the end of the The risk management and compliance norms are applicable to Category III AIFs employing leverage. The norms require Category III AIFs employing leverage to comply with the following: Have a comprehensive risk management framework supported by an independent risk management function as well as a strong and independent compliance function, appropriate to the size, complexity and risk profile of the AIF; Further, the compliance function is required to be supported by sound and controlled operations and infrastructure, adequate resources and checks and balances in operations; During the interim period, the AIFs are required to submit the reports by sending an to aifreporting@sebi.gov.in within Maintain appropriate records of the trades/transactions performed and

3 make available such information to SEBI, whenever called for; and Provide full disclosure to the investors about conflicts of interest and how the same are managed. Such conflicts shall be disclosed to the investors in the placement memorandum and by separate correspondence when such conflicts may arise. Such information shall also be disclosed to SEBI, when required. Prudential requirements AIFs should ensure that the marketing documents of the AIF are distributed on a private basis only to its proposed investors and should be in accordance with the placement memorandum of the AIF. Prudential requirements in respect of leverage have been prescribed in respect of Category III AIFs employing leverage, whether through investment in derivatives or by borrowing or by any other means. The leverage of a Category III AIF should not exceed two times the Net Asset Value (NAV) of the Category III AIF (at the individual scheme level), at any point of time. Leverage shall be calculated as the ratio of the total exposure to the NAV of the AIF. Accordingly, Leverage = Total exposure {Longs + Shorts (after offsetting as permitted)} NAV For the purpose of calculation of leverage: in both the spot market and the derivative market. Further, idle cash and cash equivalents shall not be included in the calculation of total exposure. Temporary borrowing arrangements which relate to and are fully covered by capital commitments from investors need not be included in calculation of leverage. NAV of the AIF shall be the sum of value of all securities adjusted for mark to market gains/losses (including cash and cash equivalents). The NAV shall exclude the funds borrowed by the AIF. Off-setting of positions shall be allowed for calculation of leverage for transactions entered into for hedging and portfolio rebalancing. Category III AIFs employing leverage shall report to the custodian, on a daily basis, the amount of leverage at the end of the day (based on closing prices). Breach in leverage limits In case of breach in leverage limits, the AIF shall be required to comply with the following: Send a report to the custodian intimating the breach of leverage limits; Send a report to all its clients intimating the breach along with reasons for the same on the next working day; The total exposure of shall be the sum of market value of all the securities/ contracts held by AIF. The total exposure at any point of time will be a sum of exposure through instruments Square off the excess exposure and bring back the leverage within the prescribed limit by end of next working day.

4 Subsequent to square off, send a confirmation to all clients by end of the day on which the exposure is squared off. In case of breach in leverage limits, the custodian shall be required to comply with the following: Send a report to SEBI providing name of the AIF, the extent of breach and reasons for the same on the next working day; and Send a confirmation to SEBI in respect of squaring off of the excess exposure by end of the day on which the exposure is squared off. Redemption norms Suspension of redemptions by the Manager shall be justified only: Under exceptional circumstances provided that such suspension is exclusively in the best interest of investors of the AIF; or If the suspension is required under the AIF Regulations or required by SEBI. Disclose in the placement memorandum, the possibility of suspension of redemptions to the investors in exceptional circumstances; Build the operational capability to suspend redemptions in an orderly and efficient manner; The redemption norms apply to open ended Category III AIFs (for existing as well as new schemes). The Manager of open ended Category III AIFs shall: Ensure adequate liquidity of to meet the redemption obligations and other liabilities; Establish, implement and maintain an appropriate liquidity management policy and process to ensure that the liquidity of the various underlying assets is consistent with the overall liquidity profile of the scheme/ AIF while making any investments. The Manager of the open ended Category III AIFs shall comply with the following conditions in connection with suspension of redemptions of open ended Category III AIFs: Not accept new subscriptions during the suspension of the redemptions; Appropriately document and communicate to the SEBI and investors, the decision to suspend redemptions along with the reasons for the suspension and the planned actions; Regularly review the suspension and take all necessary steps in order to resume normal operations at the earliest, having regard to the best interest of investors; and Keep SEBI and investors informed as soon as possible, about the actions undertaken throughout the period of suspension and the decision to resume normal operations.

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