Foundation — Who is who in the AIF ecosystem

7.1 The four constituents

A fund is never one person. The AIF industry is nurtured by the private capital ecosystem that consists primarily of (a) investors, looking out for alternative investment opportunities, (b) alternative investment managers, having the expertise to identify, invest, manage and harvest returns for investors, (c) sponsors, who initiate and float the AIFs (more often the managers themselves) and (d) external service providers who facilitate and make up the ecosystem.

Remember the order, because the exam likes to shuffle it: investors, managers, sponsors, service providers. Trustees come in as a fifth party only when the fund is a trust — and in India most AIFs are trusts, so in practice you will almost always see a trustee too.

With the advent of an organised AIF industry and introduction of the SEBI (Alternative Investment Funds) Regulations, 2012, AIFs witnessed significant growth after 2012 and many of these constituents of the private capital ecosystem developed significantly in subsequent years.

Think of it the way a Bollywood film gets made. The producer puts up the seed money and registers the banner — that is the sponsor. The director decides what to shoot, whom to cast, when to release — that is the investment manager. The financiers and studios who fund the picture are the investors. The trustee is the auditor-cum-guardian the financiers insist on, who holds the money in escrow and makes sure the director spends it on the film that was promised. And the camera rental house, the accountant, the lawyer, the distributor — those are the service providers.

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7.1.1.1 Investors / Contributors — who actually writes the cheque

In the global/ Indian markets, the following entities are some of the key investors in the AIF industry depending on applicable regulatory framework.

Foundations and Endowments

A Foundation is a not-for-profit organisation that donates funds and provides support to other organisations, for charitable purposes. An Endowment is an investment fund established by an individual or institution, such as a university, hospital, or foundation, to be used for pre-defined purposes, with a principal protection objective.

Why do they suit AIFs? Foundations and Endowments have long-term horizons and large corpuses, which enable them to invest over longer gestation periods and manage the risk of illiquidity. They need to invest these with an objective to continue to be able to meet the foundation or endowment objective or philanthropic objectives.

Note the two words the exam tests: long-term horizons and large corpuses. That combination is what lets an investor swallow a seven-year lock-in without flinching. An endowment also carries a principal protection objective — the corpus must survive so the scholarship can be paid every year, forever.

Insurance Companies and Pension Funds

Investments from both private and public sector pension funds have been a significant catalyst in the growth of AIFs, globally. Insurance companies are ideally positioned with large, long-term, corpuses to become AIF investors.

But India has a brake: In India, Insurance Companies and Pension Funds have regulatory caps on their asset exposures in alternative investments in the unlisted space in particular. Since these funds form the largest pool of domestic capital in India, their role is crucial in the development of AIF industry in India.

Read that twice. They are simultaneously the largest pool of domestic capital and capped by their own regulators. LIC and EPFO cannot simply decide to put 20 per cent into private equity; IRDAI and PFRDA rules limit them. That is why the growth of Indian AIFs has leaned so heavily on HNIs and offshore money instead.

Sovereign Wealth Funds (SWF)

In recent times, due to large trade surpluses generated by oil trade and global commerce, Sovereign Wealth Funds were started by several countries such as members of the OPEC (notably Kuwait, Saudi Arabia, Qatar, UAE), Norway, China, Japan, Singapore and Malaysia. These SWFs allocate funds in various sectors of the market, through the AIF route. Indian AIF Markets have witnessed a large influx of capital from Sovereign Wealth Funds, in listed equities, start-ups, infrastructure development and in the AIF market.

The source of an SWF is a trade surplus — a country earns more foreign exchange than it spends, and parks the excess in a national investment fund. If you have read about GIC and Temasek of Singapore, ADIA of Abu Dhabi, or Norway's oil fund writing cheques into Indian infrastructure and warehousing platforms, you have already met this investor class.

Family Offices and High Net-worth Individual (HNI) Investors

In the years following 2012, Indian AIF industry is being led by HNI accounts under Private Banking Managers and investment advisors, family offices, corporate investors, domestic bank promoted AIF funds and offshore investors. Family Office consultants played a vital role in deploying funds to the AIF Industry, as a diversification tool. HNI Investors have shown keen interest in long-term, high-risk investments, apart from the traditional investments in real estate, gold and equities.

This is the distinctively Indian part of the story. In the United States, endowments and pensions lead. In India, AIF growth is being led by HNIs and family offices — the promoter who sold his auto-components business, the second-generation family that has exited a listed company, the surgeon with a large practice. Their advisers use AIFs as a diversification tool away from the traditional Indian trio of real estate, gold and equities.

Fund of Funds (FoF)

A Fund of Funds is a pooled investment vehicle, which invests in other AIFs in the industry, with the purpose of achieving greater diversification across different investment strategies. Separately Managed Accounts (SMA) are a carve-out, from the fund structure. While Indian Fund of Funds are still evolving, global markets have witnessed a significant growth in the Fund of Funds AUM.

Two terms in one paragraph. FoF = a fund that buys other funds, so the investor gets diversification across strategies with one cheque. SMA = a carve-out from the fund structure, i.e. an account managed separately for one large investor rather than pooled with everyone else.

The regulatory numbers every investor must clear

Under the AIF Regulations, Indian, foreign and non-resident Indian (NRI) investors can be contributories to the corpus of an AIF. However, the minimum investment requirement of each investor is INR 1 crore. The minimum corpus in each scheme shall be INR 20 crore and the maximum number of investors in a single scheme shall not exceed 1000. Moreover, keeping in view the character of an AIF, they are allowed to raise their corpus from investors only through private placement.

Burn these four into memory:

Foreign investors are governed by the provisions of FEMA. All resident Indian investors (both institutional and non-institutional) can invest in AIFs from their domestic sources. However, domestic institutional investors (DIIs) such as banks, insurance companies and pension funds are further governed by their respective regulations on their eligibility and quantum of investment.

And the definition the exam quietly relies on: Corpus means the total amount of funds committed by investors to the Alternative Investment Fund by way of a written contract or any such document as on a particular date. Corpus is committed, not collected. Keep that word in mind; the whole of section 7.1.5 hangs on it.

SEBI introduced the concept of Accredited Investors (AI) in order to provide flexibility to high net worth investors and institutional investors when investing in Accredited Investors only funds (including large value funds), angel funds etc. under AIFs. The AIs may avail flexibility in minimum investment amount and concessions from specific regulatory requirements applicable to investment products, subject to specific conditions.

What the investor is actually called

Investors under the AIF regulations are called 'unit holders or contributors' or 'partners' or 'shareholders' depending upon the structure adopted for the AIF (trust, LLP or a company). In case of AIF trust, the corpus is represented by unit capital. In the case of a company, it is represented by share capital; and in the case of a LLP, it is represented as limited liability partnership interest.

The investment corpus of the AIF trust is known as the 'unit capital'. Unit capital is defined as the beneficial interest of an investor in the AIF or the respective scheme. Unit holder gets proportionate beneficial interest in the corpus based on the number of units held. The economic benefit of the unit will be denoted by the growth in the unit value represented by its net asset value (NAV) that is disclosed by the AIF periodically.

Recently, SEBI has notified that all Digital Platforms provided by AIFs to their investors shall be compliant with the provisions of the Rights of Persons with Disabilities Act, 2016 and corresponding rules. This shall ensure ease of access of Digital Platforms by persons with disabilities, thereby facilitating their increased participation in the securities markets.

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7.1.1.2 Sponsors — the one who starts it

Sponsor means any person or entity that is responsible for the formation and registration of the AIFs with SEBI, and includes promoter in case of a company and designated partner in case of a limited liability partnership.

After seeking registration of AIF, the sponsor invests in the capital of the company or the partnership. In case the AIF is set up as a trust, the sponsor would contribute to the capital of the investment management company.

The sponsors or designated partners, as the case may be, shall perform the critical functions of sponsoring the fund, defining the theme, constituting the fund in the appropriate structure, registration with SEBI and formation of the initial and subsequent corpuses from time to time. Sponsor can also be the manager of AIFs.

The eligibility test: The sponsor should satisfy the requirements of 'fit and proper person' based on the criteria specified in Schedule II of the SEBI (Intermediaries) Regulations, 2008.

The notification rules — and these two are constantly swapped in questions:

• Any change in the sponsor or designated partner shall be informed to SEBI — intimation, after the fact.
• Where there is a change in control of the AIF, prior approval from SEBI is required to be taken by the AIF — permission, before the fact.

Sponsors can be any person or persons including institutions or companies.

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7.1.1.3 Trustees — only when it is a trust

A Trustee or Trustee Company is appointed when the AIF is constituted as a Trust. However, there is no requirement for appointment of a Registered SEBI Trustee under SEBI (Alternative Investment Funds) Regulations, 2012.

This is one of the highest-yield facts in the chapter, and it surprises people who have studied mutual funds. In a mutual fund, the trustee company is a regulated, registered entity. In an AIF, SEBI does not require the trustee to be SEBI-registered.

Though these Regulations do not specifically provide for the qualification requirements or certification or legal form for trustees, they do have laid down the code of conduct for trustees. SEBI reviews the appointment of the trustee at the time of registration of the AIF and subsequent changes need to be notified and approved by SEBI.

So: no registration requirement, no prescribed qualification or legal form — but there is a code of conduct, and SEBI does review the appointment at registration. Not regulated as an entity; supervised as a role.

The trustee should be a person of ability, integrity and not be guilty of moral turpitude, any economic offence or violation of any securities law. The trustee cannot be the manager, director (including independent director), officer, employee of an investment management company.

Notice the bracket: including independent director. Being "independent" on the AMC board does not rescue you — you still cannot be the trustee.

The trustee shall ensure that all transactions entered into by the managers are in compliance with the regulations and the scheme's objectives and intent, and shall ensure that the interests of the investors are not compromised in any dealings with distributors, other service providers and even unit holders of other schemes in the AIF.

Read the last five words carefully: even unit holders of other schemes in the AIF. The trustee protects scheme A's investors from being disadvantaged in favour of scheme B's investors of the same fund house.

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7.1.1.4 Investment Manager — the one who does the work

Manager is the entity that is appointed by the Sponsor of the AIF, to manage its investments and may also be same as the sponsor of the Fund. The Manager should have the necessary skill and expertise to identify favourable investment opportunities and have adequate experience in financial services, investment planning, portfolio management and investment management.

Managers should be able to frame a suitable investment strategy, as per the economic cycles, market sentiments, time horizon and exit strategy or redemption plan of the fund. Managers also need to keep investors informed of the progress of the fund, investments made, key terms of the fund, new developments in the industry impacting the fund, launch of follow on funds and so on.

Managers should satisfy the requirements of 'fit and proper person' based on the criteria specified in Schedule II of the SEBI (Intermediaries) Regulations, 2008. Any change in the appointment of Manager shall be informed to SEBI and where there is a change in control of the investment management company, prior approval from SEBI is required to be taken by the AIF.

Same two-speed rule as for sponsors: change in appointment = inform; change in control = prior approval.

As per SEBI (Alternative Investment Funds) Regulations, 2012, the AIF appoints an asset management company which manages and plays the role of an investment manager for the AIF. In limited liability partnership (LLP) structure that is widely prevalent abroad, the investment managers (individuals involved) are known as general partners (GPs) or designated partners.

The six general obligations

The Sponsors and/or Managers and/or Trustees of AIF have the following general obligations and responsibilities, to ensure transparency:

1. Appointing a Custodian: The Sponsor or Manager of an AIF shall compulsorily appoint a custodian, registered with SEBI, for safekeeping of securities and shall keep custody of securities and goods received in delivery against physical settlement of commodity derivatives.
2. Review Policies and Procedures: The Sponsor or Manager shall review policies and procedures of the AIF, along with its implementation, on a regular basis. This enhances transparency and allows investors to take informed investment decisions.
3. Audited Financials: Books of accounts of the AIF shall be audited annually by a qualified auditor.
4. Dispute Resolution Mechanism: The AIF, along with its Sponsor and/or Manager shall lay down appropriate procedures for resolution of disputes between the investors and the Fund, whether through arbitration or any such mechanism as mutually decided between the investors and the Fund.
5. Maintenance of Records: The Sponsor and/or Manager of the AIF is required to maintain, for a period of 5 years after the winding up of the fund, records such as assets under the scheme/fund, valuation policies and practices, investment strategies, details of investors and their capital contribution and investment decision-making process.
6. Inspection: Sponsors and Managers are required to co-operate with SEBI by providing all required information for conducting inspection of records of the AIF with respect to activities of fund, assessment of systemic risk or prevention of fraud.

The number to remember in obligation 5 is 5 years after the winding up — not five years from the transaction, not five years from registration. The clock starts when the fund closes down.

The Sponsor/Manager is obliged to address investor complaints, provide any information sought by SEBI, maintain necessary records, ensure transparency and take all steps to address conflict of interest as specified in SEBI (Alternative Investment Funds) Regulations.

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Conflicts of interest — the map

The Sponsor and Manager/Trustee of an AIF have a fiduciary duty towards investors in the fund. They are bound to disclose all conflicts of interests as and when they arise or are likely to arise. Every AIF shall have a Conflict of Interest Policy, which helps to identify and mitigate the potential conflicts. Managers and Sponsors have the responsibility to monitor the compliance towards the conflict of interest policy.

AIF can have potential sources of conflicts at various levels, when dealing with service providers, clients or even with employees dealing on behalf of the fund. The Manager shall envisage every possible conflict during the operations of the Fund.

At Fund-Constituent Level

• Employees of Sponsor Company, Asset Management Company, Trustee and Service Providers should not have potential conflicts, when disclosing material information to their clients.
• Ideally, no potential conflict should prevail between investors and the manager of AIF. However, conflicts may exist that needs to be disclosed and resolved as per conflict resolution policy.
• Employees of all companies shall put the clients' interest over their personal interest. Employees should not solicit gifts, hard/soft commissions, among others.
• Conflicts, within Co-Investments by the Manager, shall be disclosed to the potential investors and existing investors, before any allocation being made towards these investments.
• Disclose the potential conflict if the Trustee is a group or associate entity of the AIF, or sponsor/manager of the fund, or have one or more directors in common.

At Employee or Staff Level

• Economic interest of the employee, acting on behalf of the AIF, should not be contrary to the best interest of the fund and its clients/investors.
• Employees should not be biased toward the result of the transaction, as a result of a personal, family, friendship or such other relationship with the counterparty.
• The staff member should not be employed, or act on behalf of, another entity which shares the same economic interest or has the same business as the employer organization.

All conflicts, whether present or potential, shall be disclosed to the Compliance function. The Manager should have internal policies within the Fund, to train employees and stakeholders in identifying the conflict, taking the recommended measure as per policy and disclose the same to the Manager.

Conflict of Interest Policy should briefly describe the following: Nature of potential conflicts of interest which could arise at various levels of the Fund. Methodology proposed to be adopted by the Manager for effective mitigation of conflicts. Disclosure mechanism to inform investors about the risk arising out of such potential conflicts and seek their acknowledgement towards existence of potential investment risks.

Three parts to the policy: nature, methodology, disclosure mechanism. Notice that the disclosure part goes further than telling — it must seek their acknowledgement.

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The five roles an investment manager actually plays

The important aspects of role play of investment managers are as follows.

1. Deal Sourcing

An AIF manager must identify favorable opportunities, source and complete successful transactions to generate profit and support the raising of further funds. A significant amount of effort and resource is invested in prospecting for transactions and relationship management with external agencies and individuals who may give access to deals. These include investment bankers, chartered accountants, corporate advisers, consulting firms, senior corporate heads and executives, policy makers and others. A large part of the investment manager's time is devoted to networking to create a wider ecosystem for deal generation and execution.

2. Structuring and Investing

Investment managers need not only be industry specialists but should have very profound deal making skills as well. They have to be keen negotiators and at the same time motivated team leaders to engage with corporate managements and founders of investee companies. They have to create the desired blend of incentives and returns while managing the associated risks.

3. Active Management

AIF managers have become hands-on managers of their investments. While they do not specifically assume day-to-day management control, they are actively involved in setting and monitoring the implementation of strategy, either as members of the boards of investee companies or by being observers or advising on important policy matters. This is the basis of the argument that AIF investment management is an alternative model of corporate governance to mitigate agency risk in corporate management.

Note the boundary: hands-on, but not day-to-day management control. Board seat, observer seat, policy advice — yes. Running the factory — no.

4. Harvest Returns

The investment managers have to understand the industry and market cycles, their own investment horizon, exit strategy and appropriately harvest returns from their investments. Since AIF is a long term investment strategy associated with illiquidity in many of the fund investments, harvesting returns by managing exit risks is probably the most important skill attribute of an investment manager.

The workbook itself ranks this one: probably the most important skill attribute of an investment manager. If a question asks which function matters most, the answer is harvesting returns.

5. Relationship Management with Investors

Investment managers also need to engage skillfully with their investors such that they are always kept informed of the progress of their fund, new developments shaping the AIF scenario and their fund in particular, launch of follow on funds and so on. This would require timely, regular and appropriate engagement strategy.

How each layer gets paid

The fund managers being executives of the investment management company earn the following remuneration for the services rendered — A salary from the investment management company. A profit sharing or bonus if any, from the profits of the investment management company.

The investment management company earns the following remuneration for the services rendered to the AIF — Management fees. Additional returns if any, from the AIF based on performance of the fund and the terms of the investment agreement. Share of exit loads and other fees as may be defined in the PPM.

Two levels, and the exam separates them. The individual fund manager gets a salary plus bonus from the AMC. The investment management company gets management fees, additional returns and a share of exit loads from the AIF.

In an LLP structure of an AIF, the investment managers are also partners, along with the investors in the fund. In such a situation, the managers are also contributories to the AIF like other investors and their share of the AIF returns would also be available to them as per the terms of the partnership agreement. In the Indian scenario, such contribution is mandatory under the appropriate regulations.

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7.1.2 Crowdfunding and Corporate Venture Funding

"Crowdfunding is the use of small amounts of capital from a large number of individuals to finance a new business venture." SEBI's own definition, from a consultation paper: "a solicitation of funds (small amounts) from multiple investors through a web-based platform or social networking site for a specific project, business venture or social cause."

With the emergence of social media as a cost-effective platform for dissemination of information, it has become feasible for small scale entrepreneurs and start-up founders to appeal to a wider section of the society to raise capital for a stated purpose or to finance a business venture. Crowdfunding is enabled through a technology platform which acts as an intermediary to connect fund seekers with potential investors / donors. As far as start-up businesses are concerned, crowdfunding acts as a catalyst for seed stage financing.

Though crowdfunding may be used for commercial as well as social enterprises, donations are largely for social causes while loans and equity investments are meant for commercial businesses. So far, crowdfunding has proved effective for objectives that have a social or humanitarian appeal rather than a business venture.

Two regulatory pointers to memorise:

• Loans sought through crowdfunding are known as 'Peer-to-Peer Lending' or 'P2P Lending' which fall under the regulatory purview of the RBI. Not SEBI. RBI.
• Equity crowdfunding is quite uncommon in India due to the prevalence of private placement regulations in India — specifically Section 42 of the Companies Act 2013 read with The Companies (Prospectus and Allotment of Securities) Rules, 2014.

In addition, when business ventures require higher amounts of capital, crowdfunding can prove to be infeasible and may exceed the permissible levels. SEBI in its consultative paper further highlighted the benefits of crowdfunding for start-ups as it reduces the cost of capital by diversifying risk among a large number of retail investors. However, SEBI has also highlighted the associated risk of exposing retail investors to early stage financing of businesses. There would also be no standardisation of disclosures and transparency to make informed investment decisions.

Corporate Venture Capital

Corporate Venture Capital (CVC) is defined by the Business Dictionary as the "practice where a large firm takes an equity stake in a small but innovative or specialist firm, to which it may also provide management and marketing expertise; the objective is to gain a specific competitive advantage".

CVC has been around for a fairly long time and has been used by large corporates such as Microsoft and Intel to nurture technology start-ups that innovate and prove to be synergistic with their own domains.

The distinction that gets tested: The essential difference between venture capital and CVC is that VC is a pooling concept while CVC is an on-balance sheet investment by a corporate entity. Hence venture capital investing is a part of the financial industry while CVC is in the nature of strategic investment by a company in any domain.

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7.1.3 Co-investments

Co-investments are a unique market practice in the AIF industry. As per SEBI (AIF) Regulations, co-investment means investment made by a Manager or Sponsor or investor of Category I AIFs and Category II AIFs in unlisted securities of investee companies where such Category I AIFs and Category II AIFs make investment.

Two limits are baked into that definition: Category I and Category II only (not Category III), and unlisted securities only.

The workbook's own illustration: a scheme of an AIF is making an investment in a company for say INR 100 crore as part of the scheme's portfolio, on behalf of investors in the pool. If the need of the company is INR 300 crore, the manager of the AIF, may offer this additional investment opportunity to any investor of the scheme of AIF who may want to invest in addition to their investment through the AIF.

As per the SEBI (AIF) Regulations, co-investment facilities are provided to the investors of Category I AIFs and Category II AIFs in the following 2 ways:

a. through a Co-investment Portfolio Manager as specified under SEBI (Portfolio Managers) Regulations, 2020. Under this arrangement, an investor gets the right to directly invest in an investee company in parallel to the investment being made by the AIF.

b. by launching a separate co-investment scheme (CIV scheme) under SEBI (AIF) Regulations. CIV scheme is a scheme of a Category I AIF or Category II AIF which facilitates co-investment to the investors of a particular scheme of an AIF, in unlisted securities of an investee company, where the scheme of the AIF is making investment or has invested.

As far as fund documentation goes, the investor negotiates the special right of co-investment with the AIF at the time of subscription to the fund. In view of SEBI's requirement to have a CIV within the AIF structure, the documentation for co-investment would be structured through the CIV. Since the PMS route is also available for offering co-investments, the investment manager has the option to decide which route is more feasible in a given case.

The rationale for the investor in having such co-investment right is to be in a position to benefit from a larger direct exposure to an attractive investment opportunity that may bring overall improvement in the return on the portfolio. Without the co-investment right, the investor's return depends upon the performance of the scheme alone. Co-investment rights are not a standard feature and these are generally offered to accredited investors by the fund managers.

Two exam hooks: the right is negotiated at the time of subscription, not when the deal appears; and it is not a standard feature — generally offered to accredited investors.

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7.1.4 Service Providers — the eleven hired hands

Why does a fund outsource so much? AIFs generally have a manager and its key investment team and research associates on their pay-roll. Performing operational activities may fall beyond the bandwidth for such small team-sizes, generally consisting of 5 to 10 employees for a mid-sized fund. AIF, thus, appoints various service providers for other activities related to the fund.

Remember the number: 5 to 10 employees for a mid-sized fund. That is why an AIF looks like a small office running a very large amount of money.

7.1.4.1 Merchant Bankers

Merchant bankers are appointed by the fund to perform various activities related to launch of schemes. AIFs shall file the Private Placement Memorandum (PPM) with SEBI through a SEBI registered Merchant Banker only, at the time of seeking registration or launching new schemes. However, intimation with respect to specific change in the terms of PPM may not be required to be submitted through a merchant banker and may be filed directly with SEBI.

As per SEBI (AIF) Regulations, a merchant banker, so appointed by the fund, shall not be an associate of the AIF, its sponsor, manager or trustee.

Their services: Merchant banker conducts independent due diligence of all the disclosures and its adequacy in the PPM and also provide a due diligence certificate which is required to be filed at the time of launching a new scheme or a fund or annual updates of PPM. Sponsor/ Manager of the fund, through a merchant banker, files the draft PPM to SEBI for their comments at the time of first or any subsequent scheme launches. Merchant banker ensures to incorporate the comments, received from SEBI, in the final PPM prior to launch of the scheme.

7.1.4.2 Registrar and Transfer Agents

Subscriptions and redemptions made by different class of unit holders must be accounted for, by AIF. The Registrar and Transfer Agent (RTA) is responsible to oversee the functions such as the issue of new class of units, partly-paid units, transfer of units, full and partial redemption calls, payment of exit load, expenses and fees by the selling unit holder, etc. In addition to these functions, RTAs have expanded their scope of operations, as some established companies also offer secretarial and administration services, along-with the traditional services.

Why an RTA is now compulsory: The Central Government has notified the Registrars to Issue and/ or Share Transfer Agents (RTAs) to act as collecting agents. In this regard, SEBI issued a circular stating that all RTAs registered under the SEBI (Registrars to an Issue and Share Transfer Agents) Regulations, 1993 shall be acting as 'collecting agents' to collect stamp duty on issue, transfer and sale of units of AIFs. Therefore, appointment of RTAs by an AIF is made compulsory to enable collection of applicable stamp duty.

7.1.4.3 Custodian

Asset allocators need to consider depositories and custodians not only in the context of the securities that they hold but also with regard to the safekeeping of assets underlying the investment pools in which they invest. As part of this role, the custodian needs to accept and give delivery of securities for the regular investment transactions of the fund. Since securities held by AIFs are in dematerialised form, the custodian is responsible for settlement of transactions and ensuring that the dematerialised investment accounts of the fund reflect the correct position at any time. The custodian may perform additional activities, such as tax withholding, proxy voting and also track corporate actions such as dividends, bonus and rights issues in companies where the fund has invested.

All custodians need to register with SEBI under the SEBI (Custodian) Regulations 1996. As per the AIF Regulations:

1. Sponsor or Manager of AIFs shall compulsorily appoint a custodian for safekeeping of securities of the fund.
2. Custodian, appointed by the Sponsors or Managers of Category III AIFs shall keep custody of securities and goods received in delivery against physical settlement of commodity derivatives.
3. Custodians shall report information regarding investments of AIFs as specified by SEBI.

The custodian is appointed by the sponsor or manager of the AIF. Also, custodians for a scheme of an AIF shall be appointed prior to the date of first investment of the scheme. A custodial agreement is entered into between them. As per SEBI (Alternative Investment Funds) Regulations, the custodian shall not be a related party to the sponsors or designated partners, unless specific conditions are fulfilled.

Timing rule to memorise: appointed prior to the date of first investment of the scheme.

7.1.4.4 Fund Administrators or Fund Accountants

Fund Administrators play a crucial support function to Manager of AIFs. They perform the following support activities: Maintenance of funds books and records and compliance with statutory requirements. Accounting and allocation of income and expense accruals. Providing global regulatory compliance reporting solutions. Providing Tax reporting solutions and services. Conducting NAV calculation, valuation services and Risk Reporting. Providing access to database vendors, assisting with dealing-related enquiries and providing information relating to funds, securities, prices and dealing procedures. Preparing manual and electronic payment instructions to settle fund expenses and maintaining an electronic payments library to ensure daily reconciliation of all cash and security balances. Preparing and distributing investment manager statements, interim financial reports and annual reports. Providing necessary support to fund auditors.

The high-yield sentence: It would be pertinent to note that Fund Accountant or Fund Administrator is not a regulated function in India unlike in other developed markets. Compare with the custodian, who must register under the Custodian Regulations 1996.

Many foreign funds have the support functions of fund administration, performed through Fund Administrators established in India. Custodian also, typically, offers the said services along with its custody services and offerings. There are several other vendors which can also be used, or the functions can be performed in-house, if the number of investors is small or NAV computation is not that frequent within the fund.

7.1.4.5 Fund Infrastructure

AIFs depend on robust platforms and software for trade execution. Speed of trade execution is critical for the success for investors and investment managers. Trading Platforms, used internally by the AIF or outsourced to third-party vendors, help Managers get real-time data on fund-level and firm-level positions, client accounts and related fees. State-of-the-art technology and infrastructure are one of the most important success factors for Investment Managers, in today's technology-driven world, as they seek data dissemination from global markets, segments and geographies. Mitigation of cyber-crime risks and frauds is also a concern for Investment Managers, as they are responsible for client data in their fiduciary responsibility.

The most common systems used in AIF are Order Management Systems (OMS), a real time price terminal, other databases for fundamental analysis like Bloomberg, Reuters, etc.

7.1.4.6 Distributors and Placement Agents

One of the key developments that would shape the growth and proliferation of the AIF industry in India would be the role played by distributors and placement agents, just as in the case of the mutual fund industry which grew phenomenally in India since 1994. They are important in not only the selling function but in the creation of wider awareness and familiarity among the investor community with regard to AIF products, services, investment strategies and their return potential.

A distributor can be empanelled with more than one AIFs. Distributors can be individuals or institutions such as distribution companies, broking companies and banks. However, AIF product distribution skill requires proper training and thorough understanding of the industry and the products.

AIF investors are meant to be sophisticated investors with higher risk appetite. As AIFs bear a higher risk of investment, investors also need higher risk-taking ability and willingness to invest in such assets. Distributors have to understand the risk-return profile and suitability of every scheme, launched by AIFs, for the investors/clients on a case-to-case basis. They should have a complete understanding of the operations of AIF, the investment strategy deployed, targeted asset classes, industries and sectors for investments, which can help them map the requirements of investors with the funds they distribute.

7.1.4.7 Tax Advisors

Tax Advisors are appointed by AIF managers to get advice on various aspects of fund management and transactions including domiciling the funds. Offshore Funds, in tax-friendly jurisdictions, have proved to be beneficial for investors and avoid cascading effects of taxation for AIFs. Tax Advisors also serve investors, typically foreign portfolio investors, in fund structuring, deal structuring, tax compliance and due diligence, when they look to invest in domestic AIF market or related securities. For Indian AIF, tax advisors would typically help the funds in calculating pre and post-tax NAV, estimating advance tax and tax deducted at source and various other aspects.

7.1.4.8 Legal Advisors

Drafting of legal agreements and legal documentation is done by third-party legal advisors or in-house legal counsels appointed by the AIF. Legal agreements are the basis of the contract between the Investors and the Fund. Depending on the structure of the fund entity, geographical location and targeted investor, legal advisors are responsible to draft the legal documents. Fund structures may sometimes be complex, which can require a number of agreements and legal documents to be signed by various stakeholders in the AIF.

7.1.4.9 Auditors

Statutory auditors, PPM auditors and Internal auditors are appointed by AIFs as they sign-off on the financial statements, Annual PPM Audit and internal audits, as the case may be. All the books of accounts of the AIF shall be audited annually by a qualified auditor, similarly PPM audit is mandated each year to be performed by a CA or CS.

Three kinds of auditor: statutory, PPM and internal. And note who may do the PPM audit: a CA or CS.

7.1.4.10 Investment Advisors

Offshore funds may seek investment advisory services, especially when looking to invest in domestic markets and in niche industry sectors. Domestic investment advisors sign investment advisory agreements to seek best execution for their clients. They provide industry-specific insights and potential investee companies, commensurate with the risk-return objectives and investment constraints of the Fund.

The two sentences most likely to be tested: It would be ideal to note that these are non-binding advice and investment manager may choose to execute or leave the same. And: The Investment Advisors are paid advisory fees from the investment manager for their services. Domestic funds do not generally have the practice of appointing investment advisors.

So the advisory fee is paid by the investment manager, not charged to the fund — and this is mainly an offshore fund practice.

7.1.4.11 Independent Valuers

AIF Managers appoint independent valuers to compute and carry out valuation of the investments of the scheme of the AIFs in the manner specified by SEBI. Independent valuers should have a minimum of 3 years of experience in valuation of unlisted securities.

Minimum 3 years of experience in valuation of unlisted securities. Remember the number and the word unlisted.