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Foreign investment supervision strengthened alternative investment funds (AIF) could affect the flow of funds from the Cayman Islands and the UAE, which are currently on a gray list issued by the Financial Action Task Force (FATF), the global watchdog that combats money laundering and terrorist financing. Currently, Indian Alternative Investment Funds are estimated to earn 10-15% yields from investors in the Cayman Islands and UAE.
On Friday, the Securities and Exchange Board of India (Sebi) said that foreign investors or investment groups that contribute 25 per cent or more in alternative investment funds, or as determined by control, should not be listed on the UN Security Council or under the FATF rules in the anti-investment fund. Residents of countries with deficiencies in money laundering and terrorism strategies.
The foreign investor should be a resident of a country whose securities market regulator is a signatory to the multilateral or bilateral Memorandum of Understanding between the International Organization of Securities Commissions and Sebi.
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“Most of the money flowing into AIF comes from FATF-compliant regions and IOSCO signatories. However, Sebi’s new guidelines may affect investments from the UAE and the Cayman Islands, which are in the Financial Action Task Force gray list. US investors typically move their investments from Cayman to the Indian AIF, and Cayman forms a significant part of foreign investment,” said Siddarth Pai, partner at 3one4 Capital.
Investors from the Cayman Islands and the UAE may now have to set up special purpose vehicles in jurisdictions such as Singapore and Luxembourg to channel their investments into alternative investment funds in India, Pai said.
While the Sebi Notice will affect foreign investment from the UAE and the Cayman Islands, it will also create uncertainty and increase the risk of raising funds from other foreign jurisdictions that may not currently be on the gray list but may in the future will be added, at which point investors will be barred from making subsequent contributions to the fund.
“Sebi’s new order may be problematic for closed AIFs with maturities of 10-12 years. Fund managers must now be extra careful to ensure that investments come from jurisdictions that are more stable from FATF’s point of view, otherwise they risk undermining AIFs structural risk,” said Richie Sancheti, founder of law firm Richie Sancheti Associates.
Vaneesa Agrawal, Managing Partner at Thinking Legal, said: “The fact that the greylist changes three times a year creates uncertainty for the ecosystem, in addition to increasing compliance for AIF managers. It can be challenging for fund managers to ensure continued compliance with the circular over the life of the fund, ranging from eight to 12 years,” Agrawal added.
The gray list is published by FATF in February, June and October each year, and countries are added and removed from the list based on the review. Mauritius, for example, was placed on the gray list in February 2020 and left in October 2021.
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Sebi’s circular said that if an investor who joins an AIF scheme subsequently fails to meet certain conditions, the manager of the AIF is not allowed to withdraw any further contributions from the investor until the conditions are met again. This also applies to investors already enrolled in an existing AIF scheme.
Sunil Gidwani, partner at Nangia Andersen, said it was difficult to estimate the amount of investment in affected countries because the AIF does not report country investor data to the regulator in its regular reports. “The requirements for significant equity or control of FATF non-compliant countries are similar to those in the FPI regulations. Therefore, AIF must comply with this additional screening when attracting investors. Bars are in additional drawdown. Therefore, Effective existing investments can be preserved,” Andersen added.
Thinking Legal’s Agrawal said funds will have to conduct additional KYC checks on investors to assess whether they meet the new criteria. Funds will have to look at investor stakes and internal documents to ensure control belongs to FATF-compliant investors. That would result in additional compliance costs for funds, she said.
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