SEBI Clarifies Investment Restrictions for Category III AIFs on ETFs

Investment Restrictions for Category III AIFs: Clarification from SEBI

The Securities and Exchange Board of India (SEBI) has recently addressed the permissible investment avenues for Category III Alternative Investment Funds (AIFs). This communication was prompted by a request from ASKWA Multi Opportunities Fund for informal guidance regarding investments in Exchange Traded Funds (ETFs) aimed at generating regular income.

Key Insights from SEBI's Response

SEBI's response provides critical insights into the regulatory framework governing Category III AIFs and is highlighted as follows:

1. Regulation 18 of AIF Regulations

SEBI emphasizes that Category III AIFs are permitted to invest in:

Securities of both listed and unlisted investee companies
Derivatives
Units of other AIFs
Complex or structured products

However, it is important to note that mutual fund schemes, including ETFs, are not explicitly included in the list of permissible investments.

2. Definition of "Investee Company"

Under Regulation 2(1)(o) of AIF Regulations, an "investee company" refers to any corporate entity where AIFs may invest. This definition does not include mutual fund schemes or ETFs, further clarifying the restrictions on such investments.

3. ETF Classification under Mutual Fund Regulations

According to Regulation 2(1)(jb) of the Securities and Exchange Board of India (Mutual Funds) Regulations, 1996, an ETF is categorized as a mutual fund scheme that invests in securities in proportion to an underlying index. Although ETFs are listed and traded on exchange platforms, they do not qualify as permissible investments for Category III AIFs.

4. Alternative Options for Category III AIFs

While direct investments in mutual fund schemes or ETFs are prohibited, SEBI allows Category III AIFs to temporarily invest in liquid mutual funds. This provision is available until the funds are allocated according to investment objectives or distributed to investors, as stipulated in the fund's documentation.

Conclusion

SEBI's interpretative letter confirms the necessity for Category III AIFs to strictly adhere to designated investment options outlined in the regulations. While mutual fund schemes, including ETFs, present appealing investment prospects, they are outside the scope of permissible investments for Category III AIFs.