In an interpretative letter sought under the SEBI (Informal Guidance) Scheme, 2003 (“Informal Guidance”), the markets regulator has clarified that the investment manager of an alternative investment fund (“AIF”) can provide investment management services to an offshore fund only as a SEBI-licensed portfolio manager under the SEBI (Portfolio Managers) Regulations, 2012 (“PM Regulations”). SEBI also reiterated that the investment managers of AIFs are considered to be regulated by SEBI. In this post, we will explore the queries, SEBI’s responses, and implications for the industry.
Ace Lansdowne Investment Services LLP (“Investment Manager”) is the manager of Ace Lansdowne India Investment Fund, a category III AIF (“Fund”) registered with SEBI under the SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”).
The Investment Manager proposes to manage an offshore fund, which would be set up in Ireland to seek funds from non-resident Indians in order to make investments in the listed securities of Indian companies through the Foreign Portfolio Investment (“FPI”)  route.
Queries, SEBI responses, and implications of the Informal Guidance
1. Whether the Investment Manager of a SEBI registered AIF can provide investment management services to the offshore fund? If yes, (i) whether the Investment Manager is required to obtain registration as a ‘portfolio manager’ under the PM Regulations in order to provide such management services to an offshore fund; or (ii) whether it is exempted from obtaining such registration since its activities are regulated under the AIF Regulations?
SEBI has taken a conservative and strict view that the manager of a SEBI registered AIF can provide investment management services to an offshore fund provided it is registered with SEBI as a ‘portfolio manager’ under the PM Regulations. SEBI has clarified that there is no exemption available to a manager of an AIF from obtaining registration under the PM Regulations. Further, the markets regulator stated that unlike the SEBI (Investment Advisers) Regulations, 2013 (“IA Regulations”), which exempt an Indian adviser advising persons based outside India exclusively from the requirement of obtaining registration with SEBI as an investment advisor, the PM Regulations do not provide for any exemptions from registration. In fact, the IA Regulations also exempt other SEBI regulated entities from its scope – inter alia, a manager of a SEBI registered AIF, and a SEBI registered portfolio manager who provides any investment advice to its clients incidental to their primary activity.
Further, an AIF manager can provide investment management services to only such offshore fund that qualifies as an eligible investment fund as defined under Section 9A (3) of the Income Tax Act, 1961 (the “IT Act”). An eligible investment fund means a fund established or incorporated or registered outside India, which collects funds from its members for investing it for their benefit and fulfils the conditions as specified under Section 9A (3) of the IT Act. An eligible fund manager, in respect of an eligible investment fund, means any person who is engaged in the activity of fund management and fulfils conditions as specified under Section 9A (3) of the IT Act.
In this regard, the said Investment Manager had submitted to SEBI that the proposed offshore fund in Ireland would fulfil all the conditions referred to in Section 9A (3) of the Income Tax Act, 1961 and would, therefore, be considered as an ‘eligible investment fund.’
Despite the permission to manage such offshore fund, Indian managers are advised to avoid taking decisions, especially pertaining to the key management and commercial decisions, for offshore funds. It is so advised because if the place of effective management (“POEM”) is in India, the offshore fund’s tax resident status will change and would be subject to taxation under Indian laws.. In order to avoid the POEM risk, an Indian manager could provide non-binding advice to the offshore entity, while the final management / decision making is retained at the offshore level.
2. Will the Investment Manager be considered as a ‘regulated’ entity in terms of the AIF Regulations?
SEBI has confirmed that the manager of an AIF is considered as a regulated entity in terms of the AIF Regulations. In this regard, reference is made to certain provisions of the AIF Regulations such as the requirement of being a ‘fit and proper person’ in terms of Schedule II of the SEBI (Intermediaries) Regulations, 2008; having continuing interest in the AIF; disclosing its investment in the AIF to the investors of the AIF; and being obliged to appear before SEBI for personal representation if so directed
The clarity provided by SEBI affirms the view on this point, i.e. managers of AIFs are considered as “regulated” by SEBI, even though they do not directly hold any licence in their name. The confirmation of being “regulated” by SEBI has a few important (and very specific) implications, a couple of examples are explained below.
In the context of fund management activity in the International Financial Services Centre (“IFSC”), the International Financial Services Centres Authority (Fund Management) Regulations, 2022 (“FM Regulations”) regulate the fund management entity (“FME”) and not the fund. The FME may either be an entity newly incorporated in IFSC or may be a branch of an existing entity (however, branch structure is not permitted for a Registered FME (Retail) as explained in the FM Regulations). As per the branch structure, the FME may be a branch of an entity, which is “already registered and/or regulated by a financial sector regulator in India or a foreign jurisdiction for conducting similar activities.” Hence, it can be understood that since an AIF manager is already “regulated” by SEBI, it may commence fund management activities in IFSC by simply setting up a branch office and without setting up a fresh entity in IFSC.
Secondly, in the context of receiving foreign capital through Foreign Direct Investment (“FDI”), an AIF manager may receive up to 100% foreign investment through the automatic route if it is involved in financial services activities “regulated” by financial sector regulators, viz., RBI, SEBI, IRDA, PFRDA, NHB or any other financial sector regulator as may be notified by the Government of India. However, it is relevant to note that 100% automatic FDI is permitted only if all activities of an AIF manager are “regulated” activities. In case such manager is involved in any other business, which is outside the purview of regulated activities (for example, providing investment advice to foreign entities being exempt from SEBI licensing requirements), then it would be considered as part regulated and part unregulated and hence, the FDI would need to come through the Government approval route. Schedule I of the Foreign Exchange Management (Non-debt Instruments Rules), 2019 also clarifies that the Government approval route would be applicable for financial services activities that are completely unregulated, and where there is a doubt regarding the regulatory oversight.
While SEBI has thrown light on the scope and applicability of the PM Regulations, and has considered the position of AIF managers as “regulated”, the overall flavour of the informal guidance points towards higher degree of regulation in the asset management space. This interpretation might prompt asset managers providing services to foreign persons to classify their activities as ‘investment advice’ rather than ‘portfolio management’ for a higher degree of flexibility and independence.
 ‘manager’ means any person or entity who is appointed by the alternative investment fund to manage its investments by whatever name called and may also be same as the sponsor of the Fund.
 ‘non-resident Indian’ or ‘NRI’ is an individual resident outside India who is citizen of India.
 ‘Foreign Portfolio Investment’ or ‘FPI’ is any investment made by a person resident outside India in equity instruments where such investment is (a) less than 10 percent of the post issue paid-up equity capital on a fully diluted basis of a listed Indian company or (b) less than 10 percent of the paid-up value of each series of equity instruments of a listed Indian company.