RBI and Sebi must redo its overseas investment policy for AIFs

This backlog is a challenge, especially for angel funds that are primed to invest in startups, where nimbleness is key. The AIF industry has already made representations for increasing this investment limit. Can Sebi explore alternate policies without seeking RBI’s approval?

RBI sets the overall limit and Sebi grants approvals after scanning applications. No separate permission from RBI is required thereafter. Sebi okays applications on a rolling basis.

This means once the limit is used up, until there are exits by an AIF that allow the amount to be pooled back, subsequent requests are put on hold. There is no data on the available pool, the number of applications pending with Sebi, and estimated time for their approval.

In May 2021, RBI had doubled the overseas investment limit from $750 million on account of the growing Indo-US SaaS exuberance. At a time when the Indian SaaS market is expected to grow to $50-70 billion by 2030 and with the artificial intelligence (AI) market expected to be at $200 billion by 2025, RBI and Sebi should offer solutions to improve the current regulatory setup.

Policymakers could set different caps for different fund categories because of their differing risk appetite and typical deal size. The current limit of $1.5 billion applies across all three categories of funds, which is a big disadvantage for angel funds.

Category 3 funds typically don’t utilize much of this amount. Sebi had internally deliberated upon segregating limits for each of the three categories, but discarded the idea as data that angel fund investments are strong enough to merit a separate quota had not supported this cause.

Sebi is also concerned that by setting different quotas for each category of AIF, the limit could remain unused in a single category, depriving others of a chance. If RBI is worried about the foreign exchange implications of raising the cap, then quotas within the overall would enhance forex outgo control; if it looks as if allotment ratios need flexibility, this could be done. The aim should be for Sebi to keep approving applications on a rolling basis.

Perhaps differing limits can be explored based on ownership. For example, Indian-owned funds could have a higher cap than foreign-owned funds based in India if this delivers better risk diversification. It is within Sebi’s powers to restructure the quota system even within the overall limit.

This would not need RBI’s nod.

Parallelly, Sebi should introduce a transparency ticker with useful data points on applications and available limits to help AIFs plan their investments. Where Sebi may require RBI’s support is if it explores the concept of deemed/post-facto approvals, which, with necessary riders, can ensure a smooth approval process. Lack of clarity on approvals has resulted in the emergence of innovative investment structures, such as those involving call and put options.

In the world of investment, time is of the essence. Yet, in some instances, by the time an application approval is through, the startup being eyed is already vying for funds for its next round, usually at a higher valuation. Angel funds are then left in the lurch as they are late for the earlier round and don’t have Sebi approval for subsequent rounds.

Remember, when an AIF finds that it cannot use the amount approved, it goes back to the pool and is made available for the next application. The same fund cannot use it for any other proposed overseas investment.

Sebi has, however, clarified through informal means that an AIF may be exempt from the minimum investment requirement of ₹25 lakh in some cases. An AIF though is still required to apply for clearance.

In response to a question by Lets Venture Advisors LLP (investment manager of LV Angel Fund), Sebi stated that it is willing to exempt funds if they receive shares from another fund or startup for reasons such as restructuring, and no new transactions or fresh investments are being made.

This informal guidance offers little respite to angel funds looking at overseas investments, given on the current application queue.

The worry is that due to all this uncertainty around AIF investments, they may be deprived of overseas investment opportunities. To expedite investment timelines, funds prefer to be based abroad. Resident individuals also prefer to invest through foreign vehicles.

Indian regulators should revise investment policies to enable funds based in India to make the most of all opportunities.

The author is a corporate lawyer focusing on M&As, commercial contracts and securities law.