The last few years have seen some exciting developments in the Indian private fund industry. Domestic private fund managers have found a lot of traction in the Indian market and witnessed exponential growth. A lot of credit for this goes to the Securities and Exchange Board of India (“SEBI”) in issuing the Securities and Exchange Board (Alternative Investment Funds) Regulations, 2012 (“AIF Regulations”), notified on May 21, 2012.
The AIF Regulations were drafted with an eye on market developments and were designed to encourage various types of private funds, from angel funds and venture capital funds right up to sector agnostic private equity and hedge funds. The industry reacted positively to the new regime and in a short span of about 3 years, 158 alternative investment funds (“AIFs”) were registered with the SEBI under the AIF Regulations. As of June 30, 2015, AIFs had collectively raised commitments of more than Rs. 25,000 crores from the investors and more than Rs. 12,400 crores of these commitments have been drawn down. 
One continuing restriction that affected the AIFs, and was most frequently pointed out by fund managers as a major limitation, was the inability to accept foreign investments in AIFs structured as trusts (which was an overwhelming majority of AIFs). While SEBI did permit foreign investors to invest in AIFs under the AIF Regulations, the Government of India did not permit the same under the Foreign Direct Investment Policy of India (“FDI Policy”), without prior approval of the Foreign Investment Promotion Board (“FIPB”). Obtaining the approval from FIPB was cumbersome, and generally came with stiff riders, which effectively discouraged most AIFs from seeking such approval.
The Reserve Bank of India (“RBI”) issued a notification on November 16, 2015 (“RBI Notification”) which permitted persons resident or registered outside India, including registered foreign portfolio investors and non-resident Indians (“NRIs”) to invest in units of AIFs without prior FIPB approval, on certain terms and conditions. The persons outside India who acquire units of the AIF have also been permitted to sell or redeem them in accordance with the SEBI or RBI regulations, or to pledge these units to procure credit facilities. This is a welcome change and addresses a long standing demand of the industry.
The FDI Policy also governs downstream investments by foreign owned and controlled Indian companies, and in certain situations, treats such investments on par with foreign investments. So far, there has been some uncertainty on whether the downstream aspects of the FDI Policy would apply to AIFs with foreign investors and if so, on what basis an AIF would be determined to be foreign owned and controlled. The RBI Notification has now clarified that the amount of foreign investment in the corpus of the AIF will not be the determining factor on whether the AIF is Indian owned and controlled. If the sponsor or  manager of the AIF is Indian owned and controlled, then the AIF will be treated as an Indian owned and controlled fund, even if it has a substantial foreign investment in the corpus. It is further clarified that AIFs with individuals as sponsors and managers would be considered as Indian owned and controlled if such individuals are resident Indian citizens. If the sponsors or managers are not individuals or companies but are any other form of corporate entity, then the SEBI will determine whether they are foreign owned and controlled. However, in a slight anomaly, the RBI Notification seems to suggest that if either the sponsor or the manager of the AIF are LLPs, then the AIF would not be permitted to accept foreign investments.
In the event an AIF is not an Indian owned and controlled fund, then the downstream investments by such AIF will need to conform to the sectoral caps, conditions and specific provisions under the FDI Policy applicable to foreign investments. However, downstream investments by Indian owned and controlled AIFs will be treated as domestic investment and the FDI Policy will not apply to such downstream investments.
This amendment implements the Government’s intent to allow foreign investments in the domestic private fund industry in India and seems to be a part of the ongoing push towards further liberalisation for foreign and NRI investments in the Indian economy. This is a shot in the arm for the private equity industry in India and has the potential to channelize a lot of investments into Indian funds from foreign investors, especially if some tax clarifications and amendments sought by the industry are carried out.
 There is some ambiguity on whether both, the sponsor and manager need to be Indian owned and controlled to reach this determination.
Jay Gandhi is a partner in the investment funds practice of Shardul Amarchand Mangaldas & Co. and can be reached at email@example.com
Views expressed herein are personal.
Attachment: Foreign Investments in AIFs