SEBI has, at its Board meeting of 29th June, 2021, taken some baby steps to introduce and recognise a new category of investors – the Accredited Investors (‘AIs’) who are persons of high net worth / income. This has been followed up by amendments to the respective SEBI regulations on 3rd August, 2021. These changes should open up a new and wide channel of raising finance from informed and capable investors, particularly in areas where the present regulations are too restrictive.
This is not a new concept internationally. Many countries such as the USA, Canada, Singapore and even China have provisions for such a category of persons who are deemed to be well aware, if not sophisticated, and also having sufficient net worth so as to be able to bear losses in risky investments. Many rules are relaxed for such persons and issuers / intermediaries are able to issue complex, high risk / high return products to such persons at terms that are mutually agreed rather than statutorily prescribed. Thus, on the one hand, entities that cannot otherwise raise finance without crossing many hurdles can now raise finance more easily from such persons, on the other hand, such persons have wider avenues of investments to aim for higher returns at risks which they understand and can even manage.
In other words, AIs are expected to be sophisticated high net worth investors who do not need elaborate hand-holding by the regulator. They can evaluate complex, high risk / high return products / services and negotiate terms flexibly to protect their interests.
COMPLEX SEBI REGULATIONS AIMED AT THE NAÏVE AND UNSOPHISTICATED INVESTOR
SEBI’s regulations generally are models of micro-management. Having seen small investors repeatedly suffering in their investments, and perhaps also considering the reality of Indian markets, the rules in capital markets tend to bend towards elaborate controls. Parties generally cannot, even by mutual agreement, waive the many requirements of law enacted for the protection of investors.
A portfolio manager, for example, cannot accept a client with less than Rs. 50 lakhs of investment even if the client is well informed / capable. He also cannot invest more than 25% of the portfolio in unlisted securities under discretionary management, even if the client is agreeable to this. Similarly, Alternative Investment Funds have restrictions which cannot be avoided. Investment Advisers, too, face a very elaborate set of rules which govern almost every aspect of their business, including even the fees that they can charge. Thus, even if an informed client is willing to pay higher fees to get expert advice, the investment adviser is limited by the regulations.
The result of all this is that needy issuers are starved of funds and well-informed investors deprived of avenues with the potential of higher returns.
CONSULTATION PAPER ISSUED IN FEBRUARY, 2021
SEBI had initiated this process in February, 2021 by issuing a consultation paper proposing a framework for AIs and seeking public comments. This has now been finalised and amendments accordingly made to the regulations relating to Alternative Investment Funds, Portfolio Managers and Investment Advisers.
Who would be recognised as Accredited Investors?
As per the new framework, a person can obtain a certificate as an AI on the basis of net worth / assets or income, or a combination of the two. For example, an individual / HUF / family trust can be an AI if its annual income is at least Rs. 2 crores or net worth is at least Rs. 7.50 crores, with at least half of it in financial assets. Or it can be a combination of at least Rs. 1 crore annual income and net worth of Rs. 5 crores (with at least half in financial assets).
For other trusts, a net asset worth of at least Rs. 50 crores can qualify them as AIs. For corporates, too, a net worth of Rs. 50 crores is necessary. A partnership firm would be eligible if each partner is individually eligible. Similar parameters are provided for non-residents such as non-resident Indians, family trusts / other trusts, corporates, etc. Government departments, development agencies and Qualified Institutional Buyers, etc., would be AIs without any such minimum requirements.
Interestingly, a further category of AIs has been specified, viz., Large Value Accredited Investors. This would apply in case of Portfolio Managers and would be persons who have agreed to invest at least Rs. 10 crores.
A strange aspect is that, unlike some countries in the West, SEBI has not permitted educated / experienced investors to qualify as AIs. Indeed, having qualification or experience is not deemed to be even relevant! Thus, for example, Chartered Accountants or even CFAs, though trained to be well-versed with finance, cannot only by virtue of the fact of being qualified and competent, be recognised as AIs. They can act as advisers to AIs, but not be AIs themselves, unless they have the minimum size of assets / income.
Further, again unlike many western countries, merely having a minimum income / net worth is not enough. A formal certification as an AI is needed from certain bodies recognised for this purpose. A fee would have to be paid to them for grant of such a certificate. Curiously, although the details have not been notified, it appears from the Consultation Paper that the certificate is likely to be valid only for one year at a time and will have to be renewed annually.
The Consultation Paper had proposed yet another strange condition. Persons who desire to provide financial products / advice to AIs would not only need to obtain a copy of such a certificate from the AIs, but will also need to additionally approach the certifying agency and reconfirm with them. This would be a needless additional hurdle. Hopefully, the process may actually end up being simpler with such confirmation being quickly provided online on an automated basis after due verification by the certifying agency. However, it would be best that this requirement is not mandated when the further details are notified.
Nature of relaxations from regulations available for transactions with AIs
While ideally, an informed and capable investor should not face any hurdles in his decision-making power for making investments, even if the provisions are meant for protection, there will not be total relaxation. Instead, perhaps with the intention of testing the waters and going in gradually, SEBI has given partial relaxation from the regulations. In fact, the relaxations as proposed are few and far between. The minimum investment required, the terms on which contracts of providing services can be made, the fees that can be charged, the extent to which investments in unlisted securities can be made, etc., are some relaxations proposed.
The amendments are primarily made in the SEBI regulations governing Alternative Investment Funds, Portfolio Managers and Investment Advisers. The Consultation Paper / SEBI Board meeting has talked of amendments to other regulations, too, and it is possible that more changes may be made in the near future.
BENEFITS OF THE NEW CONCEPT
The new scheme can be expected to benefit intermediaries, investors and indeed the market. They would have more freedom to enter into arrangements and investments with risks and complexities that they are comfortable with. It should also result in availability of far more funds, from many more persons and by many more issuers. Today, many such investments simply cannot take place because of protective legal requirements. There would also be more flexibility for the parties involved. The amendments also create a sub-category of AIs called Large Value Accredited Investors, as also a separate category of fund called Large Value Fund for Accredited Investors. These would enable further flexibility to larger investors who expectedly can undertake more informed risks.
Can an AI opt out of the scheme either generally or on a case-to-case basis?
There are a few other concerns. Even if a person is an AI, he may not always want to waive the regulatory protection. He may have more than the prescribed size of net worth, etc. However, in certain cases, he may prefer not to invest as an AI. It seems that there is no bar on him from opting out.
However, care would have to be taken in the paperwork / agreements to ensure that there is no inadvertent waiver. It is common, however, that investors end up signing on the dotted line on long documents containing fine print. This is even more important considering that the benchmark for being an AI is only financial and not knowledge / qualifications.
An interesting issue would still remain as to whether, in case of disputes, his being an AI could be used against him and he be assumed to be an informed and sophisticated investor.
