Sebi Comes Out With Consultation Paper On Direct Schemes Of Alternative Investment Funds

The Securities and Exchange Board of India has come out with a consultation paper on direct plan schemes of AIFs and trail model for distribution commission in AIF in an effort to reduce mis-selling and high commission charges

The Securities and Exchange Board of India (Sebi) has come out with a consultation paper on alternative investment funds (AIFs) in an effort to reduce mis-selling and high commission charges. The objective of the consultation paper is to seek comments, inputs and/or suggestions from all stakeholders on proposals relating to direct plans for schemes of AIFs, and introduction of trail model for distribution commission in AIFs. 

Under the Sebi AIF Regulations, 2012, AIFs can currently offer a ‘direct plan’ for investors in their private placement memorandum (PPM) at their option. Such a direct plan would not entail any distribution or placement fees for the investor. Also, AIF regulations do not place any restrictions on how much of any distribution commission or placement fee can be paid on an upfront basis to intermediaries. 

Also, in order to reduce instances of mis-selling, Sebi (Mutual Funds) Regulations, 1996 and Sebi (Portfolio Managers) Regulations, 2020 mandate that asset management companies (AMCs) and portfolio managers should adopt a full trail model of commission to their distributors.

Direct Plan For AIF Schemes

The consultation paper has now come up with new proposals for consideration. These include, among others, mandating direct plans for AIF. 

AIF regulations permit AIFs to raise funds from investors only on a private placement basis. An investor may also invest in an AIF through a Sebi-registered investment advisor or portfolio manager.

Also, investors looking to invest in an AIF through an investment advisor or portfolio manager, are prone to be charged twice, once in the form of the investment advisor’s advisory fee or portfolio manager’s portfolio management fee, and separately through the AIF distribution fee. 

To address the issue of potential double charge to the investors, a proposal to mandate AIFs to offer the option of direct plan to investors was placed before the alternative investment policy advisory committee (AIPAC). Accordingly, AIFs have now been mandated to offer the option of a direct plan for investors, entailing no distribution and/or placement fee. 

AIFs will also have to ensure that any investor approaching an AIF through an intermediary, that is separately charging the investor a fee (such as advisory or portfolio management fee), invests in the AIF via the direct plan route only. 

Investors on-boarded via the direct plan are to be provided for an adjusted higher number of units, taking into account the lower distribution charges applicable to them versus other investors, such that all investors would continue to see the same net asset value (NAV) on their unit holdings. 

Trail Model Of Distribution Commission In AIF

Sebi said that at present there are no regulatory guidelines in place with respect to commission and/or distribution fees in case of AIFs. 

Also, in some cases, the upfront commissions for AIF distribution has gone up to around 4-5 per cent of the committed amount. Such high upfront commissions, particularly in sharp contrast to the trail commissions for other products, increase the chances of mis-selling of AIF schemes, Sebi said.

As such, to address this issue of probable mis-selling of AIFs, and to ensure parity across other Sebi products and offerings, a proposal on adopting trail model of distribution commission in AIFs was placed before AIPAC. 

Accordingly, AIPAC recommended that in case of category III AIFs, which are somewhat more directly comparable with mutual funds and/or portfolio manager services, investors may be charged placement fee and/or distribution fee on a trail basis. 

Investors may also be charged on a trail basis in case of category I AIFs and category II AIFs, however, certain higher amount of distribution fee (namely, one-third of the present value of the total distribution fee) may be paid upfront in the first year. 

This is to acknowledge the need for some reasonable incentives to ensure the flow of savings into private capital markets, Sebi said, adding that a move towards trail model of commission will ensure that the distribution of AIFs is in alignment with the interest of investors, as well as reduce the scope of mis-selling of AIFs. 

Further, this would also bring AIFs in parity with regulatory framework for portfolio managers and mutual funds by removing existing commission arbitrage among these products, Sebi said. 

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