Sebi’s AIF rule changes give fund managers more time—but add new challenges

These changes aim to resolve long-standing challenges in managing unliquidated assets while giving fund managers more operational flexibility. At the same time, they introduce new complexities that will require careful oversight to ensure investor confidence is not undermined.

This article examines the opportunities and challenges these reforms bring, and how Sebi can further strengthen its framework.

The changes

The Sebi amendments provide flexibility for AIFs by allowing more time to maximise asset valuation. These changes improve outcomes for both fund managers and investors.

Increased flexibility for fund management: One of the most notable changes introduced by Sebi is the option for AIFs to enter a “dissolution period” to manage unliquidated investments within their existing schemes. This allows funds to extend their lifecycle in a structured manner, offering fund managers more time and flexibility to dispose of these assets.

In the past, funds with unliquidated investments often struggled to wind down promptly, leading to costly administrative and legal burdens. By eliminating the need to create separate liquidation schemes, the dissolution period simplifies operations and provides an efficient path to closing out investments that would otherwise remain stranded.

The ability to manage residual investments within the existing fund structure also helps mitigate the risk of distress sales. Fund managers now have the latitude to wait for favourable market conditions or work through complex resolutions without the pressure of an impending deadline, which could result in more favourable outcomes for investors.

One-time extension for liquidation: Sebi has also introduced a one-time extension for AIFs with liquidation periods that have either expired or were set to expire before 24 July 2024.

This extension is a crucial lifeline, particularly for funds facing illiquid markets or assets that are difficult to sell. It enables fund managers to avoid hasty liquidations that might lead to suboptimal returns. For investors, the extension could result in better outcomes, as fund managers will have the necessary time to work on maximizing the value of their investments, instead of rushing into sales that could lead to unnecessary losses.

The challenges

Sebi’s changes often aim to improve market integrity and protect investors, but they can indeed bring challenges. Balancing these challenges is crucial to ensuring that the regulatory environment supports both market efficiency and investor protection.

Transparency concerns: While beneficial for fund managers, extending the holding period raises transparency issues. Delayed disclosures regarding the asset quality and performance of these unliquidated investments could erode investor trust. Sebi must enforce stringent monitoring and ensure that investors remain fully informed, even during extended holding periods.

Limited investor options in distribution: Investors may face limited choices when it comes to receiving returns from unliquidated assets. If investors are unwilling to accept in-specie distribution (where they receive the unliquidated asset directly), the investment may be written off. This approach could be detrimental to investors who are not prepared to manage such assets themselves, highlighting the need for more diverse exit options.

Valuation complexities: Accurately valuing unliquidated investments is a challenging task. The inherent subjectivity in assessing the worth of illiquid assets can lead to discrepancies between perceived and actual values, increasing the potential for disputes. Ensuring accurate, transparent valuation mechanisms will be crucial to avoiding conflict and ensuring fair outcomes for all stakeholders.

Suggested next steps

In the evolving landscape of fund management, ensuring transparency and flexibility for both investors and fund managers is crucial. To enhance this dynamic, Sebi could consider the following measures:

Standardized exit options: Sebi could explore standardized exit mechanisms for investors who are unwilling to accept in-specie distribution. Facilitating secondary market transactions for illiquid assets or establishing more structured exit strategies could provide greater flexibility to investors.

Clearer guidelines on dissolution procedures: Providing more explicit guidelines for entering and exiting the dissolution period would offer clarity for fund managers and investors alike. This could reduce confusion and ensure that all stakeholders have a clear understanding of the process.

Periodic review of the dissolution period: Sebi ould commit to reviewing the effectiveness of the dissolution period after a certain time. This would allow for adjustments to be made based on market feedback and performance, ensuring that the system remains responsive and effective.

Simplified consent mechanisms: Streamlining the consent process—perhaps through electronic voting or reducing the consent threshold—could make it easier for fund managers to make critical decisions without unnecessary delays. Simplified procedures would reduce administrative burdens and improve the agility of fund management.

The success of these reforms hinges on addressing potential transparency issues and creating more robust exit options for investors. With further refinements, these amendments could catalyse even greater growth and innovation in India’s AIF industry, while maintaining investor confidence and market integrity.

Priyesh Chheda is Founder of Arbour Investments.