The PE-VC industry in India underwent tremendous growth in the last two decades. The Government of India is introducing several measures to proactively address the inherent risks due to increasing size and support the growth of the industry. However, what will the impact of these regulations be in a private market where investors believe that the industry should remain unregulated?
Recently, we worked on a project titled “Understanding the Regulatory Framework for Private Investment Instruments” inspired by the news article (Tiwari, 2023) about SEBI proposing a standard valuation procedure in private markets. The project was intriguing because Private Market Investors have long argued that the industry must remain unregulated. Investors in the private market have the competency & resources to assess the risks and opportunities and hence don’t need the same level of protection as public market investors. Moreover, being a relatively smaller industry, the industry relies on reputational risk protection over regulation protection (Business Standard, 2013). Even then, the government seems to be quite active in the area, setting up committees and initiating discussions to understand the market by proposing policy initiatives for the industry. We endeavoured to understand the reasons for introducing regulations for private investment instruments and then assess the impact of the regulations.
Based on the arguments of private investors & investments funds, and a KB Chandrashekar report of January 2000, (SEBI, 2000) the industry must retain its flexibility, efficiency, and ability to attract investments to be successful in contributing to the economic & social success of the country, and to compete with the international venture funds. Flexibility refers to the ability of funds to structure investments as they deem fit, customize investment strategies, select companies to invest in, and more. Efficiency refers to the ability of the fund to make investments quickly which is important in a fast-paced technology environment.
If that’s the case, any regulation that doesn’t affect or positively affect the flexibility, efficiency, and ability of the funds to attract investments should be considered a step in the right direction. In 1988, the Private Market Regulatory framework was introduced to encourage entrepreneurship and technology development. Since then, the various initiatives were brought in effect through AIF regulations, 2012 and FVCI regulations, 2000. The policy proposals suggest that these initiatives were envisioned to relax taxation norms and attract foreign investments.
Through AIF regulations, the government categorized funds into 3 different categories and provides concessions and incentives for funds that invest in the economic or social growth of the country. These funds fall under category 1 as per the AIF regulations. The regulations include specifications for fund structure that a maximum of 25% of investible funds can be invested in one company. The clause, we feel, compels the funds to invest in more than one firm encouraging investment in multiple start-ups. Another clause that not more than one-third of the funds can be invested in a subscription to the IPO or listed company directs a major part of the funds to an unlisted enterprise (SEBI, 2012). Similar restrictions on fund structure and investments to manage the flow of foreign funds apply to funds registered under FVCI regulations as well. While the flexibility of the VCFs to structure the funds have limitations under the AIF and FVCI regulations, they seem reasonable as they allow the flow of capital to be focused on the growth of unlisted capital venture undertakings. The regulations have positively increased the attractiveness of the industry by providing tax-pass through status to the funds to avoid double taxation and exemptions for foreign funds on entry/exit to funds registered under FVCI.
Consolidation of policies by CBDT, RBI and SEBI under AIF regulations, 2012 was an effort to provide a single-window framework to increase the efficiency. However, in 2022, IVCA (the body governing interests of the PE-VC industry) expressed concerns about establishing a single-window framework for registration and grievance redressal which seems to indicate that the regulations were not efficient enough. This seems to have been addressed by the government in the 2023 budget. The Government announced that IFSC will be the supreme authority for all SEZ compliances by setting up a single IT system for registration and approval of various agencies (Economic Times, 2023). Even then, it will take some time to access the efficiency of the recent change.
Other recent updates include the issuance of a framework for foreign investments wherein AIFs are prohibited to raise funds from non-compliant foreign investors (IVCA, 2023), issuance of consultation papers proposing standardized valuation practices according to IPEV guidelines, review of eligibility criteria for key investment team and prescribing qualification for compliance officer or manager for AIF. While a detailed analysis is required to understand the impact of proposed changes, the policy changes seem to strike the right chords by attempting to improve the quality of capital coming in, reduce subjectivity in extant regulations, and reduce risks.
References
Business Standard, 2013. PE fund managers take kickbacks. [Online]
Available at: https://www.business-standard.com/article/markets/pe-fund-managers-take-kickbacks-111111500072_1.html
[Accessed January 2013].
Economic Times, 2023. Budget 2023 : GIFT IFSC gets a slew of incentives to increase business. [Online]
Available at: https://bfsi.economictimes.indiatimes.com/budget/union-budget-2023/budget-2023-gift-ifsc-gets-a-slew-of-incentives-to-increase-business/97534573
[Accessed February 2023].
IVCA, 2023. IVCA PE/VC Agenda – India Trend Book 2023. [Online]
Available at: https://www.ivca.in/resources/recent-reports
SEBI, 2000. Report of K.B. Chandrasekhar Committee on Venture Capital, s.l.: s.n.
SEBI, 2012. SEBI (Alternative Investment Funds) Regulations, 2012. [Online]
Available at: https://www.sebi.gov.in/legal/regulations/jun-2018/sebi-alternative-investment-funds-regulations-2012-last-amended-on-may-10-2019-_34621.html
Tiwari, K., 2023. Sebi proposes standard approach for valuation of AIF investments. [Online]
Available at: https://www.business-standard.com/article/markets/sebi-proposes-standard-approach-for-valuation-of-aif-investments-123010601087_1.html
Ruchi Agarwal (PGP ’21-23),
Prashant C (PGP ’21-23), under the guidance of Prof. Sabarinathan G