SEBI Notifies Renewed Process for PPM Filing by AIFs

PPM filings will now be based on due diligence by merchant bankers

I.  Introduction

The Securities and Exchange Board of India (“SEBI”) at its board meeting held on August 6, 2021, announced a wide array of changes to the regulatory regime governing alternative investment funds (“AIFs”) in India. We had analysed the amendments and their effect in a prior regulatory update. Amongst the changes announced was a procedural update. The securities regulator had mandated that all private placement memoranda (“PPM”), the offer document shared with potential investors in an AIF, must be filed with it through a merchant banker.

Following through with its board meeting announcement, SEBI, vide its circular dated October 21, 2021 (“Circular”), has announced that effective November 11, 2021, all PPMs must be filed with SEBI through SEBI registered merchant bankers on behalf of an AIF. Notably, this obligation of merchant bankers will typically be relevant at three stages – first, initial filing at the time of seeking registration, second, prior to launch of a new scheme under an existing AIF, and third, intimations to be made within one month of the end of the financial year, in case of any changes to the PPM. This regulatory update delves into the implications of the Circular on the framework governing AIFs in India.

II.  Role of Merchant Bankers

Merchant bankers[1], governed by the SEBI (Merchant Bankers) Regulations, 1992, have hitherto primarily been responsible for undertaking due diligence of offer documents prior to initial public offerings, and ensuring that adequate disclosures are made to potential investors by the companies offering their shares to the public. The merchant banker also submits a due diligence certificate to SEBI, at the time of filing the draft red herring prospectus.

A similar framework appears to have been adopted by SEBI for AIFs as well – the Circular requires that merchant bankers submit a due diligence certificate to SEBI, alongside the PPM, after independently conducting due diligence of all disclosures in the PPM and satisfying itself of the veracity and adequacy thereof. Notably, the Circular requires that the merchant banker be named in the PPM, and that they cannot be an associate of the AIF, its sponsor, investment manager or trustee.

A high degree of responsibility has been cast on merchant bankers with these amendments, as they are now required to undertake independent due diligence of the AIF and certify the status of AIF’s regulatory compliance with SEBI regulations.

III. Due Diligence Obligations

The Circular, alongside the duties cast on merchant bankers, provides a template diligence certificate to be submitted by them (“Certificate”). It also prescribes a checklist (as Annexure II) of confirmations and information that must be duly filled in and submitted by the merchant banker, along with the Certificate. A review of this checklist reveals that these items have been compiled by SEBI in an effort to streamline the most frequent queries and comments that it poses to fund managers after filing and before grant of registration. We have briefly summarised a few key confirmations required by this Annexure II.

(a)   Critical Disclosures in the PPM forming a part of merchant banker’s due diligence

Most of the checklist items require disclosures of information that form a part of the template PPM format prescribed by SEBI. A few important aspects that have to be confirmed by the merchant banker, as part of its due diligence certificate, are highlighted below:

  a) Item 4 Whether the merchant banker has verified that the information provided in a particular section is consistent across the PPM
b) Item 9 Whether the PPM provides that the terms of the contribution agreement are in line with the terms of the PPM
c) Item 12 Whether the scheme intends to invest in units of other AIFs
d) Item 14 Whether the merchant banker has verified that all members of the key investment team are employees or partners of the investment manager
e) Item 18 Whether the PPM discloses that delegation of activities to a third party will be in compliance with the SEBI circular dated December 15, 2011, titled ‘Guidelines on Outsourcing of Activities by Intermediaries’
f) Item 23 Whether the PPM discloses that differential rights attached to any class of units, or given through side letters, will not have adverse impact on the economic rights of other investors
g) Item 29 Whether the PPM discloses that the investment manager will establish a written conflict management policy and the timeframes for adopting such policy
h) Item 30 Whether the distribution waterfall provides for illustrations in the five different scenarios required by SEBI

(b)   Additional information sought by SEBI from merchant bankers

A few of the checklist items, to be confirmed by merchant bankers, may require additional information to be provided by the investment manager. Most of this information currently does not form a part of the SEBI prescribed PPM format, but is typically examined by SEBI during the course of its review of PPMs. These include:

a) Item 5 Clauses in the PPM that affect the pro-rata rights of any investor
b) Item 6 Role of the investors in approving investment decisions of the scheme, if any
c) Item 7 Whether the AIF proposes to engage in lending activities or extend guarantees for investee companies
d) Item 25 Whether the PPM discloses the timeframe within which any warehoused investments made by the investment manager shall have to be disclosed to investors or potential investors
e) Item 28 Whether the PPM discloses that co-investments by investors of the AIF will have to be made in compliance with the AIF Regulations as well as SEBI (Portfolio Managers) Regulations, 2020 (“PM Regulations”)

Notably, the queries pertaining to the fund providing guarantees and the applicability of the PM Regulations to co-investments by investors of AIFs are specifically required to be completed by Merchant Bankers as part of their due diligence certificate to SEBI. To minimise iterations of the regulatory filings, SEBI should clarify the necessary confirmations it expects from merchant bankers (i) in terms of the guarantees provided by AIFs, and (ii) the extent to which the PM Regulations would be applicable to co-investments by AIF’s investors.

It is also seen that investors in AIFs may, in certain cases, retain protective rights on certain critical decisions pertaining to a fund’s activities, including inter alia investment related decisions of the fund. It should be noted that going forward merchant bankers would be required to detail any role of investors in approving investment decisions of the fund.

IV. Conclusion

The PPM filing process, prescribed by the Circular, adds a key step to existing processes for setting up of a new AIF or floating of a new scheme of an existing AIF, by prescribing a detailed due diligence of the PPM by a merchant banker. This may potentially lead to higher compliance and setup costs for fund managers and add to the overall timelines for fund setup. Similar considerations of cost and time also exist for the yearly disclosure filings that must be undertaken to intimate SEBI of any changes to the PPM.

It remains to be seen whether this change would reduce the review time of PPMs by SEBI, especially in cases of applications for setting up of new AIFs or new schemes of existing AIFs.

[1] Defined under the Section 2(cb) of the SEBI (Merchant Bankers) Regulations, 1992 as ‘any person engaged  in  the  business  of  issue management either by making arrangements regarding selling, buying or subscribing to securities  or  acting  as  manager,  consultant,  adviser  or  rendering  corporate  advisory service in relation to such issue management’.