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SEBI proposals spell bad news for India

Tanuj Khosla from 3 Degrees Asset Management discusses the adverse impact of recent regulatory proposals over India's burgeoning private equity market.

It is extremely important that private equity in India, which is already facing its share of challenges, isn’t burdened with additional difficulties. Consequently many were taken by surprise by the timing of the concept paper on proposed Alternative Investment Funds regulations proposed by SEBI (Securities and Exchange Board of India – the Capital Market regulator of India) in August.

Below is a short round-up of some key proposals released by SEBI and why India’s PE industry may find little favour with them:

Fund Structure: It would be mandatory for all private pools of capital or investment funds to be registered with SEBI in one of the nine categories provided by them. Three of these categories are PIPE Funds, Private Equity Fund and Infrastructure Equity Fund.

This would be nothing but a cost and logistical burden for PE funds in India as they shall have to do multiple registrations in order to execute their investment strategy which they have stated in their Investor Memorandum. For example, a PE fund that wants to invest in unlisted companies as well as do PIPE deals must register in both categories. If an infrastructure sector-focused PE fund (and there are many around owing to the tremendous promise held by infrastructure sector in the country), it may need registration in three of the nine categories!

GP Commitment: The SEBI is proposing the sponsor of the fund shall contribute from their own account an amount of investment equal to at least 5 percent of the fund and this shall be locked in until the redemption by the last investor in the fund.

General Partners having their skin in the game isn’t a new phenomenon in the private equity industry. However putting a minimum floor of their investment is certainly not very common. While the intent here seems to be right (that of ensuring that the GPs take care of investor interests), this regulation effectively means that start-up fund managers can’t raise large funds even if they have the capability to do so as they shall need to put forward 5 percent of the AUM from their own source. Hence we can reasonably expect large PE funds in India to be run by the likes of Blackstone, Carlyle and others of their ilk who have deeper pockets.

Investment Restrictions: In the case of PIPE funds, investments would be restricted to shares of small-sized listed companies which are not in any of the market indices.

These regulations effectively bar firms from carrying out PIPE deals in large and mid-sized listed companies in India. Moreover the funds can’t do any such deals in a company that is a part of SENSEX or NIFTY. The regulator’s intent behind this provision remains unclear, but could be due to either: 

• Market volatility when a PE fund executes or exits a PIPE transaction in a company that is a part of a market index or

• Volatility in the stock price of a company having a substantial size when a PE fund executes or exits a PIPE transaction in it.

This is assumingly being done to protect retail investors. For PE funds, this restriction is not much better than the constraints imposed by VCF regulations by which they must currently comply with as they won’t have many promising listed companies to choose from. It’s possible many firms may try to circumvent this ruling by buying convertible bonds (FCCBs) of mid- and large-sized companies and then converting them to equity (even at a loss), thereby owning a minor but substantial stake. Others might be completely demotivated to invest in India which is a very worrying prospect.

In conclusion, it’s important to note the SEBI is one of the more proactive and investor-friendly regulators in the world. The regulator is attempting to walk a tightrope between developing India’s capital markets in order to attract inflows and protecting the nation’s retail investors. However it seems the SEBI is erring on the side of caution with regulations as far as private equity in India is concerned.

Over-regulation during such difficult times will definitely not be good for funds which need encouragement, companies which need capital and India which needs foreign inflows to finance its Current Account deficit.

Tanuj Khosla is currently working as a Research Analyst at 3 Degrees Asset Management, a fund management firm in Singapore. Views expressed are personal.