In response to the concerns over transparency and investor protection that have been raised in recent years, the Securities and Exchange Board of India (SEBI) has proposed a set of regulations aimed at making AIFs more transparent and investor-friendly.
The proposed guidelines address two main areas: transparency in distributor commissions and transferability of units. SEBI has released three consultation papers that suggest the next generation of reforms for AIFs. This article explores the impact of SEBI’s proposed guidelines on AIFs and what it means for investors.
Transparency in Distributor Commissions
SEBI’s proposal includes creating a trial model for distributor commissions in AIFs, which is similar to the practices already implemented in the mutual fund industry. Currently, AIFs do not have regulatory guidelines on commission or distribution fees.
According to industry feedback, in some cases, the quantum of upfront commissions for AIF distribution has gone up to around 4%-5% of the committed amount. When compared with the trail commission model of other products, this can result in the mis-spelling of AIF schemes.
In light of this, SEBI has proposed that investors in Category III AIFs be charged fees on a trail basis. Those in Category I AIFs and Category II AIFs may also be charged on a trail basis, but a certain higher amount of placement/distribution fee (one-third of the present value of the total distribution fee) may be paid upfront in the first year.
SEBI’s proposal to pay 1/3rd of the (present value of) distribution fee upfront and the rest 2/3rd on a trail basis is expected to benefit the industry from a medium to long-term perspective.
The proposal is expected to significantly reduce the chances of mis-selling AIF schemes and bring transparency to investors.
A direct plan with no distribution or placement fees
In a recent consultation paper, SEBI has proposed that AIFs be mandated to offer the option of direct plans – with no distribution or placement fees – to investors. A direct plan enables investors to invest directly without the help of intermediaries. AIFs will have to ensure that any investor approaching them through an intermediary invests only through the direct plan route. Investors who are taken via the direct plan will have to be provided for an adjusted higher number of units (given the lower distribution charges) such that the net asset AIFs operate in a complex and dynamic environment, value or NAV remains the same for all the AIF investors.
The trail commission structure will incentivize intermediaries to provide better service to their clients, as their commission payments will be tied to the performance of the AIF scheme. This will allow investors to make better-informed decisions when choosing an AIF scheme.
Transferability – Dematerialization of Units
SEBI has noted that despite the regulation of issuing AIF units in place, most AIF scheme units are not yet dematerialized and are held in physical form. Henceforth, the market regulator has proposed that the dematerialization of units of AIFs shall be made mandatory wherein all schemes of AIFs with a corpus of more than INR 500 crores shall compulsorily dematerialize their units by April 1, 2024.
The development of a secondary market for AIFs is essential to ensure liquidity in the AIF industry. The listing of AIF units would allow investors an easy exit opportunity (subject to KYC) and enable price discovery in a demand-supply mechanism. This move is expected to encourage more investors to invest in AIFs and also provide existing investors with more liquidity options.
Conflict of Interest
AIFs are allowed to deal with their associates for investing in associates, buying/selling securities to/from, availing services of them, etc. However, such related party transactions could give rise to conflicts of interest. While current regulations already have provisions to address such conflicts of interest, SEBI in the consultation paper has proposed specifically that AIFs cannot undertake such related party transactions without the approval of 75% of investors, calculated by the value of their investment in the AIF, in associates or units of AIFs managed or sponsored by its Manager, Sponsor, or associates of its Manager or Sponsor.
This proposal will promote fairness and prevent conflicts of interest in AIF transactions, thereby providing investors with greater protection. The proposal will also help to improve the reputation of AIFs in the eyes of investors, who have been concerned about the potential for conflicts of interest in AIF transactions.
Impact on Investors
- More transparent information about fees paid to intermediaries.
- Enables better-informed decisions in choosing an AIF scheme.
- Trail commission structure incentivizes intermediaries to provide better service.
But, AIFs operate in a complex and dynamic environment, so it cannot be ignored that implementing these proposed guidelines may be a challenge. Such as;
- Practical difficulties in ensuring compliance with proposed regulations.
- AIF managers may require additional resources to implement proposed regulations.
- Difficulty in ensuring all intermediaries comply with new regulations.
- It may take time for investors to understand the benefits of the new regulations and adopt AIFs as a viable investment option.
Despite these challenges, SEBI’s proposed guidelines are a step in the right direction for the Indian investment market.
By promoting transparency and investor protection, the proposed regulations are likely to attract more investors to AIFs, thereby increasing the size of the industry and contributing to the growth of the Indian economy.
Moreover, the guidelines will encourage healthy competition among AIFs and create a level playing field for all market participants. To understand the complexity of investments, it’s important to recognize that there are many factors to consider when making investment decisions. From analyzing financial statements and market trends to understanding risk and diversification, investing requires a significant amount of knowledge and skill. Even experienced investors can struggle to navigate the ever-changing landscape of the global economy.
At Rurash Financials, we understand the challenges investors face and are committed to providing our clients with the resources and guidance they need to make informed investment decisions.