The increased regulatory scrutiny on foreign investment in alternative investment funds (AIFs) could impact flows from Cayman Islands and the UAE, which are currently on the grey list put out by the Financial Action Task Force (FATF), a global watchdog that combats money laundering and terrorist financing. Currently, Indian AIFs get an estimated 10-15% from investors in Cayman Islands and UAE.
On Friday, the Securities and Exchange Board of India (Sebi) said foreign investors or an investor group contributing 25% or more in an AIF or identified on the basis of control should not be on the sanctions list specified by the United Nations Security Council or a resident of a country with strategic anti-money laundering and terrorism deficiencies as per the FATF.
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“Most of the flows into AIFs are from FATF-compliant regions and signatories to the IOSCO. Sebi’s new guidelines, however, could impact investments from UAE and Cayman Islands, which are on the FATF grey list. US investors typically route their investments from Cayman, which forms a significant chunk of foreign investment into Indian AIFs,” said Siddarth Pai, partner, 3one4 Capital.
Investors from Cayman and UAE may now have to set up special purpose vehicles in jurisdictions such as Singapore and Luxembourg to route their investments into Indian AIFs, according to Pai.
While the Sebi circular impacts foreign investment from the UAE and Cayman Islands, it will also create uncertainty and increase the risk in raising funds from other foreign jurisdictions that may not be in the grey list today but could be added in future, at which point the investor will be barred from making subsequent contributions to the fund.
“Sebi’s new diktat could be problematic for closed ended AIFs with a duration of 10-12 years. Fund managers will now have to be doubly careful to ensure that the investments are from jurisdictions that are more stable from an FATF perspective, else risk undermining the AIF structure,” said Richie Sancheti, founder of law firm Richie Sancheti Associates.
“The fact that the grey list is subject to change thrice a year will create uncertainty in the ecosystem in addition to increased compliances for AIF managers, according to Vaneesa Agrawal, managing partner, Thinking Legal. “Typically, AIFs have a fund life of eight to 12 years and ensuring continued compliance with this provision of the circular over the life of the fund could be challenging for fund managers,” Agrawal added.
The grey list is published by FATF in February, June and October every year and countries are added and dropped from the list based on review. For example, Mauritius was put on the grey list in February 2020 and exited it in October 2021.
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Sebi’s circular says if an investor who has been on-boarded to an AIF scheme subsequently does not meet the specified conditions, the manager of the AIF shall not draw down any further capital contribution from the investor until the conditions are met again. The same shall apply to investors already on-boarded to existing schemes of AIFs.
Since AIFs do not report country-wise investor data to the regulator in their periodical reports, it is difficult to estimate the quantum of investments from affected countries, said Sunil Gidwani, partner, Nangia Andersen. “The requirements in terms of significant stake or control for FATF non-compliant countries are similar to what one sees in FPI regulations. So, AIFs would have to conform to this additional screening while onboarding investors. The bar is on additional drawdown. So, effectively existing investment can stay,” Andersen added.
According to Agrawal from Thinking Legal, funds will have to carry out additional KYC checks of investors to assess whether they meet the new criteria. Funds will have to look at shareholding and internal documents of investors to ensure that the control is with FATF-compliant investors. This will lead to additional compliance costs for funds, she said.