Aaj Sikri and Vibhasa[i]
There are various investment platforms available to investors. The article deals with Mutual Fund (“MF”) and Alternate Investment Fund (“AIF”). Both AIFs and MFs are considered ‘pooled investment vehicles’ (“PIV”) as per Securities Contracts (Regulations) Act 1956 (“SCRA”) Section 2(da). It defines PIV as a fund that collects money from investors and invests them according to the regulations made by SEBI. A MF is defined as a mechanism where resources are pooled together to invest capital in securities; consequently, investors are issued units of these funds. On the other hand, any fund which is a PIV designed to collect funds from sophisticated investors (experienced investors with a high net-worth) is defined as an AIF. As per section 2(1)(b) of the AIF regulations, the primary aim of AIF is to invest per the investment policy. The difference between the two is that a MF can primarily invest in securities, money market instruments, privately placed debentures, etc. Whereas an AIF invests in start-ups, projects that are economically and socially viable. Few examples of AIFs are Angel Funds, Infrastructure Funds, and Venture Capital Funds. A MF has to seek approval from SEBI for its registration before it can collect funds from the public. Similarly, an AIF has to seek registration in one of the categories mentioned under Regulation 3 (4) (a) of the Securities and Exchange Board of India (Alternative Investment Fund) Regulations 2012 (“AIF Regulations”).
Both these investment platforms have their share of similarities and dissimilarities. Regulation 2 (1) (b) of the AIF Regulations categorically states that funds covered under the Securities and Exchange Board of India (Mutual Fund) Regulations 1996 (“MF Regulations”) will be outside the ambit of AIF. However, what if a MF, an instrument of the commoner, wants to invest in an AIF, an instrument of the sophisticated investor? This begs the question, “Whether a MF can invest in an AIF?”
The Conundrum posed by the definition of ‘Securities’
For this, we need to go back to the MF Regulations. Regulation 43 (1), an exhaustive provision, answers the question ‘where a mutual fund is allowed to invest?’ It can invest in (a) Securities, (b) Money Market Instruments, (c) Privately Placed Debentures, (d) Securities Debt Instruments, (e) Gold or Gold Related Instruments, (f) Real Estate Assets, (g) Infrastructure Debt Instruments, (h) other instruments as may be specified by SEBI. We know that an AIF is a privately pooled investment vehicle; thus, it is reasonable to assume that it is not in the nature of categories mentioned under clause (b) to (g). Therefore, the possibility of a MF investing in an AIF under any clause from (b) to (g) is ruled out. What we need to consider is clause (a), i.e., Securities. It begs the question, “what is the ambit of Securities?” While the MF Regulation does not answer this question, we need to consider the most commonly used definition of Securities as defined under the SCRA.
The definition of securities as per Section 2 (h) of SCRA includes inter alia shares, scrips, stocks, debentures, derivatives, units or any instrument issued under MF, and a PIV. It is imperative to note that a PIV [which includes an AIF as per Section 2 (da) of SCRA] was only added to the ‘definition of ‘securities’ by the 2021 SCRA amendment. This is the only relevant link between a MF and an AIF. This implies that following the 2021 amendment, a MF which ordinarily can invest in securities can now also invest in a PIV vis-à-vis an AIF and be justified under the above-mentioned reasoning.
However, one has to proceed with caution. This is a strict textual reading of the law, and SEBI has not answered this to date. Whenever it does, it is reasonable to assume that it may answer this question through a purposive interpretation of the law. This brings us to explore a counterargument.
The purposive interpretation - a counter to the theoretical possibility
Firstly, our history suggests that SEBI has tried to demarcate retail investment from institutional/sophisticated investment in India. The AIF Regulations, which are meant for sophisticated investors first started as the Venture Capital Fund Regulations in 1996. The same year the MF Regulations were issued. The reason for SEBI to introduce the MF Regulations was the entrance of the private sector in MFs in 1994. While similarly, the idea of venture capital had gained traction in 1988. Both were new players within the Indian economy, and both were instruments for investors to exercise capital in ways they never previously could. However, the idea of MFs was to allow a more accessible entry for retail and protect them from risks. Whereas AIFs were meant for institutional and sophisticated investors, managed by fund managers, requiring minimal regulation. Hence, it prompted SEBI to regulate them separately. SEBI’s philosophy in AIFs has been to act as a facilitator and regulate to the minimum to ensure disclosures occur and conflict is minimized. It follows that if the intent were to allow MFs to invest in AIFs, then in 1996 itself, SEBI would have included Venture Capital Funds in Regulation 43 (1) of the MF Regulations.
Secondly, there is a distinct difference in the nature of the funds; though both are considered PIVs, they serve different market interests and operate with different objectives. As mentioned earlier, a MF is meant for retail investors with lower net-worth, while AIFs are meant for sophisticated investors with higher net-worth. The significant difference is the size of investment between these two kinds of investors. This has been expressly mentioned, amongst other differences, in the regulator philosophy for SEBI in its consultation paper on the AIF Regulations. For instance, by increasing the minimum investment amount in AIFs from Rs. 5 lakhs to at least Rs. 25 lakhs {Regulation 19D (3) of AIF Regulations}, SEBI has intentionally created a barrier to differentiate between MFs and AIFs. Further, investment strategies and limitations for both instruments are strikingly different. For instance, recently, SEBI has limited MFs to invest in only listed or to be listed securities. However, an AIF can invest in various securities, whether listed or unlisted.
Thirdly, while carrying out the 2021 SCRA amendment, the legislature did not provide any reason for adding ‘PIV’ to the definition of ‘securities.’ However, as argued here, the intention was to rectify an irregularity vis-à-vis the Indian Stamp Act 1899. In any scenario, if the intention were to remove the barrier between MFs and AIFs, it would have been done on more specific terms.
Lastly, the consultation paper to AIF regulations also mentioned specific bars on collecting money from retail investors. For this reason, Regulation 4(b) of the AIF regulations specifically barred invitations to the public.
Therefore, from the above-mentioned arguments and locating the purpose of both the regulations, it would be reasonable to assume that MFs cannot invest in AIFs.
Concluding Remarks and Suggestions
As a result of the 2021 SCRA Amendment, it is not disputed that there is now theoretically an ability for MF to invest in AIFs, which was not possible earlier. However, given the purposive understanding of the law, whether a MF can invest in an AIF remains uncertain. Currently, there are no Informal Guidelines or FAQs by SEBI to provide an answer to this issue. It is reasonable to assume that after taking cognizance of this issue, SEBI will keep the interest of the retail investors and protect the scheme of AIF Regulations. It is suggested that; the apparent distinction between an AIF and a MF should remain intact. Therefore, to avoid confusion, the MF or AIF Regulations should require an explicit bar on intermingling post the 2021 SCRA amendment.
Aaj Sikri and Vibhasa are 4th year and 3rd year law students respectively at Jindal Global Law School, Sonipat. (They can be contacted via mail at 18jgls-aaj.s@jgu.edu.in). They are grateful to Prof. (Dr.) Umakanth Varottil, Mr. Narayan Kedia, and Mr. Saswat Mohanty for their comments on the draft version.
Comments