Ever-changing Landscape of Alternative Investments: Current Indian Scenario The participants in alternative investments market are hopeful that regulatory reforms will continue to support the growth of this industry in India

Indian Stock Markets have recently witnessed a reduction in investments from foreign institutional investors on the backdrop of a $2 billion banking fraud and widening of the Current Account Deficit to a 5-year high, among other factors.

However, with regard to alternative investments, India has been ranked No. 1 in 2017 as the 'most preferred destination' by global investors, as per the Global Limited Partner Survey, 2017 of Emerging Markets Private Equity Association. This ranking has improved from 9^th position in 2013. Moreover, the number of Alternative Investment Funds (AIFs) registered with SEBI have increased by 50% from June 30, 2016, to September 30, 2017, reaching 374 Funds.

Growth in alternative investments reflects the growth of an economy. AIFs make sure that necessary funds are made available to young entrepreneurs at different stages of their ventures and also to different "economically-desirable" industries such as Infrastructure, SME, and Social Ventures. For the investors, this is beneficial, as AIFs provide diversification benefits for portfolios of High Net-worth Individuals (HNIs) and Institutional Investors. As per SEBI Regulations, registered AIFs are divided into the following categories:

• Category I AIF: Funds which invest in socially or economically desirable ventures, like Venture Capital Funds, SME Funds, Social Venture Funds, and Infrastructure Funds.
• Category II AIF: Funds which are not a part of Category I or Category III and invest as per their Investment Mandate, such as Private Equity Funds and Debt Funds.
• Category III AIF: Funds which employ diverse and complex investment strategies to earn an above-average return, whether or not using Leverage and investing across different investment products, like Hedge Funds.

Alternative investments have grown rapidly in the past three years on account of proactive regulatory reforms, such as:

• RBI issued notification for Foreign Investments in AIFs under Automatic Route, in November, 2015. AIFs with Majority Foreign Capital will be considered as Local Funds and FDI Restrictions will not apply to such Funds if the sponsor or manager controlling the Funds is INDIAN.
• National Infrastructure Investment Fund ("NIIF") of INR 20000 crores is being set up by the Government of India.
• TaxPass-through Structure implemented for Category I and II Funds, where investors are taxed. This avoids Double Taxation.
• Category III Funds are allowed to invest in Commodity Derivatives up to 10% of its Investible Funds and use leverage up to two times.

• Real estate sector has emerged as the second most active sector in 2017.

Indian Alternative Investments Market still represents a minuscule share of the Global Market and is poised for unprecedented growth in the coming years. In order to foster growth, many regulatory reforms are yet needed. Some of the suggested measures which can be taken are:

Disclosure Requirements and Governance by the AIFs: Lack of transparency has always been a dampener in this Industry, as opposed to that in traditional investments. AIFs should make relevant disclosures and follow standardised governance practices, at a global level.

• Disclosure of relevant fund-level information should be made available to investors, especially information related to Fund Performance.
• An Investment Advisory Committee should be formed to take care of any conflicts of interest, whether during the fund's life or at the end of a fund's life.

Increased Participation from Domestic Institutional Investors: Domestic Funds will play a vital role in the development of Indian alternative investments market in the long run. This will reduce India's dependency on foreign funding. Financial institutions, like insurance companies and pension funds, manage a huge treasury and should be allowed, by their respective regulators, to invest in Category I and II AIFs.

Recognizing Potential Investors in an AIF (Accredited Investors): As per current SEBI AIF regulations, investors need to invest a minimum of INR 1 crore in an AIF in order to participate in alternative investments market since, these markets are comparatively illiquid. However, there can be investors who have sufficient net worth but do not want to invest INR 1 Crore. Hence, suitable regulations should be framed to identify potential or so-called "accredited" investors for the fund.

Individuals who satisfy the following conditions can be recognised as Accredited Investors:

• Those capable of identifying potential investments and its underlying risks.
• Having reported total income exceeding INR 50 lakhs annually in three out of previous five assessment years.

Changes to GST Framework: GST was implemented in India to prove as a catalyst in the economy. To help the alternative investments market, following changes to CGST Act can be made:

• In case of PE and VC Funds, services rendered to such funds can be charged at a rate of 5%, where the majority of the investors of an AIF are foreign investors.
• Investors in an AIF are service recipients. If foreign investment in an AIF exceeds 50%, the services received by an AIF should be considered as export of services, therefore not liable to GST.

Investments Into AIFs in International Financial Services Centres (IFSC): IFSCs are a favourable route for foreign investors to invest in AIFs. However, the current regulatory regime for the establishment of AIFs in an IFSC is restrictive and offers investment in limited products and sectors. There is a need to create a robust tax and regulatory framework to encourage investments in AIFs through IFSCs.

• Tax Exemption should be available on income earned by an offshore investor, by investing through an AIF in an IFSC.
• AIFs domiciled in an IFSC generally source funds from offshore investors. Hence, restrictions placed on domestic AIFs, for investing money overseas, should not apply to such AIFs in an IFSC.
• Domestic fund managers and sponsors should be permitted to manage AIFs domiciled in an IFSC.

Listing of AIFs on Exchange Traded Platforms: AIFs are comparatively illiquid. All AIFs, except an open-ended AIF, can be listed on a stock exchange, as per SEBI regulations. BSE has established processes to list an AIF on its platform for investments. This provides a liquidity window to investors post-listing and also allows smoother exit options to existing investors in the AIF.

Category III Fund-of-Funds ("FoF"): These funds invest in multiple Category III Funds, thus diversifying across different investment strategies of fund managers. In India, this market is yet in its initial stages. However, at the global level, FoF Market is more than $300 Billion, which is approximately 8 times the size of total Alternative Investment Market in India.

To achieve growth in FoF, there should be an option for permissible leverage to be either at the FoF level or at the level of the underlying individual portfolio of funds.

Favourable Taxation Reforms: Last, but certainly not the least, Effective Taxation Reforms are what the AIF industry in India is reviewing. Some of the recommended reforms are:

• Make Pass-through structure available to Category III AIFs.
• There should be a Unit-based Taxation Approach for AIFs listed on the Stock Exchange Platform, like mutual funds. Registered AIFs should be exempt from tax and taxes should be charged to investors as:
  • Distributin tax on income distributions – On Interest and Dividend
  • Capital gains tax n unit redemptions/transfers – On Short-term Capital Gain and Long-term Capital Gain
• Profits made by AIF on the transfer of unlisted securities should be treated as Capital Gains, and not Business Income. Allow management expenses for AIF investments to be capitalized as "cost of improvement.'
• Any loss made by the AIF should be allowed for set-off against income of investors, instead of future business profits of the Fund

The alternative investments market in India is still in its nascent stages. All the participants in this market are hopeful that regulatory reforms will continue to support the growth of this industry in India.