What to expect from the upcoming Union Budget 2023 as an AIF Asset Manager

It opened a whole new door to sophisticated investors looking to invest in products other than traditional asset classes and in varied sectors.

When it comes to products in the private debt space, the ability of AIFs to go much deeper in the market has attracted a lot of investors’ attention, resulting in deeper segmentation of risk and return in the balance sheets of institutional investors, family offices, and HNIs.

The above factors led the total number of AIF schemes in the country to more than quadruple from 250 in FY18 to over 1,000 in the present financial year.

The commitments raised, which denotes the amount clients are willing to invest in AIFs, clocked a 5-year CAGR of ~50% to ~INR 7 lakh crores as of Jun 2022.

Despite the regulatory leeway, more is expected from the governing bodies in the upcoming Union Budget to sustain the interest in AIFs and hasten the pace of its growth.

Some clarifications are needed with respect to AIFs set up both domestically and in International Financial Services Centre (IFSC), a specialized designated area in a Special Economic Zone (SEZ) located in GIFT City, Gujarat.AIFs set up in India are registered under SEBI (AIF) regulations, 2012 and are classified as Category I, II, and III AIFs depending on the investment objective and strategy.

These AIFs are considered Indian resident investment vehicles from both exchange control and taxation perspectives. From an Income tax perspective, Category I and II AIFs are accorded a tax pass-through status, whereas Category III AIFs pay tax at the fund level at the maximum marginal rate.

On the other hand, AIFs set up in IFSC are regulated by a unified regulator, International Financial Services Centres Authority (IFSCA) under IFSCA (Fund Management) Regulations, 2022.

The Investment Manager in IFSC (called a ‘Fund Management Entity or FME’) is required to obtain an FME license, which is a key distinction between IFSCA and SEBI regulations.

Interestingly, AIFs in IFSC are considered non-resident from the standpoint of exchange control, though they continue to be treated as residents from the standpoint of Income tax.

These AIFs are also registered as Category I, II, and III AIFs and are intended to be taxed in the same manner as SEBI-regulated AIFs.

Criticality for India’s financial inclusion
India is a country where debt capital markets have not succeeded in replacing banks for critical areas such as project and infrastructure finance, or in developing the mid-market space.

Today, the share of sub-AA ratings accounts for sub-5% of bond markets. To correct this, it is essential for the AIF industry to develop pooled investment products that are the safest and best way to direct household savings to debt capital markets.

Therefore, there is a critical need for the Government and regulators to support and promote AIFs as a path toward financial inclusion and the development of capital markets. Below we discuss suggestions to achieve the same.

Domestic funds under SEBI
• Regulation of the Asset Manager: Globally, fund managers are regulated by the securities regulator, with requirements of minimum capitalisation, compliance, disclosures as well as corporate governance. This provides more comfort to investors as well as ensures a certain level of quality amongst the players in the market. Given the growing size of the AIF industry, it is about time that asset managers are regulated.

• Increasing investor participation: Harmonising ticket size of investment: India provides various opportunities for investors to partake in debt or debt-like opportunities. However, the ticket sizes of investments vary. For direct bond investments, the minimum ticket size has been lowered by SEBI to INR 1 lakh recently. For ReITs and InvITs, the minimum ticket sizes stand at INR 50,000 and INR 1 lakh, respectively. For PMS, the same is INR 50 lakhs. However, for AIFs, the minimum ticket size stands at INR 1 crore and INR 25 lakh for an accredited investor.

It would be useful to have parity between these options on the basis of risk and return. Pooled investment opportunities with professional managers offer diversification and essentially lower risk – hence, it would stand to reason that the ticket size should be lower than for direct bonds.

• Accreditation can be transformational: Accreditation of investors has been introduced by SEBI as a way to determine investor maturity and therefore reduce investment ticket size. With the increase in private wealth and the growth of HNIs, it is necessary to provide a significant policy push to this initiative. If accreditation becomes “digital” and hence instantaneously verifiable, the impact on deepening AIF penetration could be transformational.

• Provide Asset Managers the option to self-select and structure: The Cat I/II/III framework was useful in setting an initial framework for creating the AIF industry. However, the utility has run its course.

(The author is Founder & CEO, Vivriti Asset Management)