VCF To AIF Transition: A Step-By-Step Approach

Posted On - 5 September, 2024 • By - Vatsal Gaur

On August 19, 2024, the Securities and Exchange Board of India (“SEBI”) released a circular (“Circular”) regarding the modalities for migration of Venture Capital Funds (“VCFs”) registered under erstwhile SEBI (Venture Capital Funds) Regulations, 1996 (“VCF Regulations”) to SEBI (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”).[1] This comes in light of the amendment notified by SEBI to provide flexibility to VCFs registered under the erstwhile VCF Regulations for migrating to AIF Regulations and to, inter-alia, avail the facility of dealing with unliquidated investments of their schemes upon expiry of tenure.[2]

Key Points

Definition of “Migrated VCF”: Under the AIF Regulations, Migration VCFs are referred to as a fund registered as a VCF under the VCF Regulations and subsequently are being registered as a VCF under Category-I AIFs.
Application Process for Registration as a Migrated VCF: The Migrated VCFs are required to submit

(i) the original certificate of registration issued under VCF Regulations; and

(ii) requisite information under the Circular which include (a) the details concerning the VCF and its trustee/manager/sponsor; (b) details about scheme of the VCF; (c) details of any past regulatory actions against the VCF; and (d) a declaration statement. The formats for these disclosures are given under the Annexure I of the Circular.

Migration Conditions for VCFs with Active Schemes: For VCFs with only schemes whose liquidation period has not expired, the following conditions apply:

(i) the facility to migrate to AIF Regulations is available until July 19, 2025;

(ii) if the private placement memorandum disclosed a definite tenure for the scheme(s), that tenure will continue after migration; and

(iii) if no definite tenure was disclosed, the residual tenure must be determined before the migration application with the approval of 75% of investors by value.

Migration Conditions for VCFs with Wound-Up Schemes: VCFs with at least one scheme that has not been wound up after its liquidation period can only migrate under the following conditions

(i) there must be no pending investor complaints regarding non-receipt of funds or securities at the time of the application;

(ii) a one-time additional liquidation period of one year (until July 19, 2025) is available for schemes that have expired liquidation periods but are not wound up; and

(iii) if the VCF also has schemes whose liquidation periods have not expired, their tenure will be determined as per the provisions concerning the tenure of the Migrated VCF, upon migration.

Upon migration to AIF Regulations, the investors, investments, and units associated with the VCF or its schemes under the VCF Regulations will automatically be considered part of the Migrated VCF or its corresponding schemes under the AIF Regulations.
Applicability of SEBI Master Circular for AIFs and other relevant circulars under AIF Regulations: The Migrated VCF would be subject to these circulars and the AIF regulations are subject to only a certain extent of applicability as per the chapters of the relevant law. For example, Chapter 1 of the Master Circular for AIFs provides for an online filing system for AIFs. Under the same, generally, AIFs are required to pay a registration pay. However, for migration, no such fee would be applicable to the VCF.
Non-Migrating VCFs: VCFs with active schemes (not yet expired liquidation periods) will be subject to enhanced regulatory reporting aligned with AIF reporting requirements. Furthermore, VCFs with at least one expired scheme will face appropriate regulatory action for operating beyond their original liquidation period.
Ineligibility for Migration: VCFs cannot migrate if (i) all schemes are wound up; or (ii) no investments have been made in active schemes. These VCFs must submit a surrender application to SEBI by March 31, 2025, or face registration cancellation.
Compliance Responsibility: The manager, trustee, and key management personnel of VCFs and Migrated VCFs are responsible for complying with the provisions of this circular.
Compliance Test Report: The trustee or sponsor must ensure that the manager’s Compliance Test Report (as per SEBI Master Circular Chapter 15 for AIFs) includes compliance with the provisions of this circular.

Analysis

This circular marks a significant regulatory shift with broad implications for the investment landscape in India. It offers VCFs enhanced flexibility, particularly in managing unliquidated investments as they approach the end of their tenure while aligning them with the more comprehensive AIF regulatory framework. It also provides a great amount of procedural clarity with the process.

For investors, this shift promises greater transparency and protection, as migrated VCFs will now be subject to rigorous disclosure and reporting requirements under AIF regulations.

However, the migration process is not without challenges; VCFs must navigate a detailed application process and ensure stringent compliance, which could be administratively demanding, especially for smaller funds. The requirement for investor approval in cases where no initial tenure was defined ensures that investors’ interests remain central during this transition.

For VCFs that choose not to migrate, the consequences are significant, as they face enhanced regulatory scrutiny and potential penalties, particularly those with expired schemes. This increased scrutiny may push non-migrating VCFs to either align with the new standards or exit the market altogether.

Final Words

The transition of VCFs to AIFs as outlined in the Circular is a step towards greater regulatory alignment and investor protection. While it poses challenges in terms of compliance and operational adjustments, it also offers opportunities for market consolidation, increased transparency, and stronger governance in the investment fund landscape. Fund managers and trustees will need to carefully navigate this transition to maximize the benefits while managing the associated risks and costs.

[1] https://www.sebi.gov.in/legal/circulars/aug-2024/modalities-for-migration-of-venture-capital-funds-registered-under-erstwhile-sebi-venture-capital-funds-regulations-1996-to-sebi-alternative-investment-funds-regulations-2012_85914.html.

[2] https://www.sebi.gov.in/legal/regulations/jul-2024/securities-and-exchange-board-of-india-alternative-investment-funds-third-amendment-regulations-2024_84929.html.

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