The new Alternative Investment Fund (AIF) regulation proposed by SEBI succeeds in sorting out the jumbled mess of funds with varied objectives that were bunched together and loosely governed by SEBI's venture capital funds regulations. These regulations, formulated in 1996, did not distinguish among venture capital funds, private equity funds, PIPE (Private Investment in Public Equity) funds, real estate funds and the various other funds that cater to affluent investors. Somewhere along the way, the distinction between these funds blurred, allowing them a broader mandate on the kind of companies they could invest in. This resulted in funds ignoring start-ups and smaller companies that really need capital, and making a beeline for the more promising companies, even listed ones. The proposed regulations address this issue by placing investment restrictions on each type of fund: PE funds should invest only in unlisted companies; PIPE funds in small listed companies that are not part of any stock market index, debt funds in debt of unlisted companies; venture capital funds only in early stage ventures, and so on. These curbs seek to ensure that the funds fulfil their prime objective — making seed capital available to start-ups or meeting requirements of unlisted or smaller listed companies.
But in its zeal to ensure that the smaller companies are not deprived of cash, the regulator may have gone too far, by mandating that such capital cannot be provided to any large- and mid-cap company that is part of any market index. The CNX-500 companies, for instance, account for almost 93 per cent of the market capitalisation of the country's equity market and are front-runners in driving economic growth. This pool of private capital is just as important to the bigger companies to fill the funding gap, especially in an environment of tight liquidity. There are other restrictions that are unnecessary: Asking each fund to seek separate registration as a company, trust or LLP could make operations cumbersome; stipulating that separate funds need to be set up for investing in infrastructure companies, for instance, effectively means that a PE, PIPE or VCF cannot invest in shares of an infrastructure company.
It is also not clear if foreign venture capital investors, who are currently regulated by the Foreign Venture Capital Investors (FVCI) regulation, will also be subject to these stringent investment restrictions. These proposals may have hardly any effect on hedge funds that are largely regulated by overseas jurisdiction and are registered as FIIs. Overall, it would pay to remember that the investment strategies of alternative investment funds are also a function of what their investors want. It is doubtful if mere regulations can ensure investor appetite for unlisted companies or smaller and riskier ventures.