Over ₹1 trillion of AIF investments circumventing rules, says Sebi’s Anant Narayan G | Stock Market News

India’s market regulator has found that investments worth more than ₹1 trillion by alternative investment funds (AIFs) were circumventing regulations, underscoring the need for a more robust investor protection-oriented approach, according to wholetime member Ananth Narayan G.

“Out of the five trillion of actual drawdown, around one trillion of investment has been questionable in terms of the regulatory intent behind those investments,” Narayan said at the Alternatives Investment Fund Summit by the Confederation of Indian Industry (CII) on Tuesday.

“This is not a small number,” he said, adding that over 20% of the drawdown amounts have raised concerns. And, these figures reflect just what has been identified so far, he pointed out.

The kinds of circumvention seen, according to Narayan, ranged from attempts to bypass Reserve Bank of India’s (RBI) non-performing asset (NPA) regulations to violations related to the Foreign Exchange Management Act (FEMA). There have also been instances of circumvention of regulations for foreign portfolio investors (FPIs).

Narayan’s argument highlighted the inherent conflict between promoting a light regulatory framework and maintaining effective oversight to prevent circumvention of laws.

Narayan emphasized that the Securities and Exchange Board of India was looking at adopting a focused approach to regulation—one that aims to crack down on the wrongdoers while ensuring that legitimate, well-intentioned market players are not unduly burdened by overbearing rules.

“We are afraid of type 1 errors, where bad things happen, but equally afraid of type 2 errors, where our regulations are so burdensome that they come in the way of good people doing better things,” Narayan said.

Narayan said Sebi was walking a fine path between too much regulation and not enough regulation for AIFs—privately pooled investment vehicles that collect funds from financial institutions or high net-worth individuals—equating them with the goose laying golden eggs. “We cannot be greedy and try and produce more eggs than is sustainable. We don’t want to kill this goose which is laying golden eggs. At the same time, we should not burden it with so much of checks and balances that it stops doing its work. So, it is a fine balance we have to walk,” he said.

According to Narayan, the new code of conduct for financial entities has been effective so far, fostering better compliance while minimizing friction in the market. Developed in collaboration with the industry stakeholders, the code laid down simple ‘dos and don’ts’ for financial entities to demonstrate that they are not circumventing the regulatory framework.

On the ongoing push from the industry to ease regulations, particularly those related to investor protection, Narayan said it’s a delicate balancing act. “AIFs by definition are supposed to be light touch regulation,” he said. “[but] We are yet to come across investors who say ‘go easy on the regulations’. Even qualified institutional buyers (QIBs), when they meet us in person, say ‘please maintain where you are’”.

Sebi’s response to requests from the industry for changes to the current structure of large-value funds reflected the regulator’s position. Industry players had proposed reducing the minimum investment threshold from ₹70 crore to ₹25 crore. However, after private discussions with large investors, it became clear that such a change would not significantly impact their investment strategies.

“The clamor for light touch regulations does not seem to be coming from investors,” Narayan said, suggesting that the industry’s demands for regulatory leniency might not align with the actual needs of the investors it claims to represent.

Focus on accredited investors

Any calls to ease regulations must be considered carefully, he said, stressing that the light-touch approach should only apply to sophisticated investors who are fully aware of the risks involved—specifically, accredited investors (AIs).

Narayan called for adopting the accredited investor model, a practice widely implemented across global markets. “If you want to join a hedge fund or invest in a private equity enterprise globally, you typically need to be an accredited investor,” he said. “We should move towards this model in India where only accredited investors participate in certain high-risk investment avenues.”

Under this model, accredited investors are those who are deemed to have the necessary knowledge, experience, and financial capability to handle higher levels of risk. By establishing clear criteria for accreditation, India could allow for more flexibility in regulation without compromising the integrity of the financial system or investor protection.

The shift towards an accredited investor system would allow Sebi to grant “light touch” regulations to those who are most capable of navigating the risks associated with alternative investment avenues. This approach, according to Narayan, would strike a balance between encouraging financial innovation and safeguarding the interests of less experienced retail investors.

Acknowledging the current challenges in building a sufficient pool of accredited investors, Narayan said these hurdles are not insurmountable. He proposed that intermediaries play a role in facilitating the accreditation process, with the regulator supporting measures to bring down costs and make the model more accessible to a broader range of investors.

“The cost of accreditation is high,” he said, “but unless you make a start, you won’t cross the bridge.”