The Indian regulators in 2012 have sought to overhaul the regulatory framework governing privately pooled funds in India. In this regard, the regulators have introduced a set of omnibus regulations in the form the SEBI1 (Alternative Investment Fund) Regulations, 2012 (AIF Regulations). Additionally, SEBI has also sought to regulate financial advisor through the Investment Advisors Regulations2. As the Indian fund industry matures, SEBI has taken cognizance of increasingly need for a sophisticated platforms for pooling of investors, chief among which was the introduction of a regime for domestic hedge funds in the form of Category III Alternative Investment Fund.

In addition to reforming the domestic market for such privately pooled capital, to augment the raising of offshore capital, SEBI introduced the Qualified Foreign Investor (QFI) regime as a distinct route for investors seeking to enter the Indian capital market.

Recent liberalization of the policy relating to Foreign Direct Investment policy by the Indian Government has opened up several sectors of the economy to foreign direct investment. In light of the aforementioned reformed, investment by PE and VC funds has revived in the Q3 of 2012.

While the new regime has create a flutter of domestic fund raising activity, with new funds being formed under the AIF Regulations, globally, out of 680 funds raising USD 270 billion in capital in 2011, only USD 12 billion were raised by funds with a mandate to invest in India. In addition, the number of exits by India focus funds also dropped, with a lower return to LPs by PE funds in 2011 as compared to 2010.


  • PE investors in Q2 looked principally to invest in well run Indian businesses and Indian affiliates of overseas corporations which are experiencing financial stress. Such transactions are expected to continue in Q4 of 2012.
  • An increase in ‘structured’ deals, as opposed to traditional growth capital investments by PE funds, indicating a cautious and performance based investments indicating the lack of confidence PE investors have in the Indian market at the moment.
  • Increasing resistance to ‘blind pool’ fund models.
  • Raising fresh capital from Limited Partners (LPs) is seen as a continuing challenge taking longer in the past few years. LPs have become more selective, evaluating re-ups and managing their investments more closely than ever to ensure capital protection, better returns and appropriate liquidity, compared to their attitude in 2007-08.
  • In the domestic context, the increase of the minimum ticket size to INR 1 crore set by the AIF regulations is likely to restrict the market only to seasoned investors.
  • Liberalization in Foreign Direct Investment policy means that PE-VC interest in consumer products (retail), BFSI sector and healthcare should grow healthily in 2012. Coupled with the highly beneficial returns arising from these sectors PE funds continue to explore IT, Energy and Healthcare sectors, which contributed to bulk of the deal value during Q2 2012.
  • Drop in IPOs means that PIPE took center stage, amounting of USD 2.4 billion in 2011, a raise of over 87% as compared to 2010.
  • Exit negotiations have become prolonged due to changes (elaborated below) in the Indian taxation regime causing industry players to be more cautious.
  • In Q2 of 2012, PE exits have been worth USD 108 million from 12 deals while in Q1 of 2012, PE exits have been worth USD 981 million from 31 deals.
  • The capital markets have been subdued which depressed the IPO exits for investors. So much so that there has been only 1 IPO in each of Q1 and Q2 of 2012, by which a PE investor has exit. The Indian PE industry has shown signs of maturing as several alternative forms of exits have been successfully tapped, including strategic sales, secondary sale of portfolio to another PE, etc.
  • However, the recent buoyancy in the capital markets led largely by the reforms drive by the government, has seen spurt of exits on the secondary market. Carlyle’s exit from HDFC has given a strong signal to PE investors investing in the BFSI space that the exit route has opened up.


  • Traditionally top global and Indian PE-VC players have continued to maintain their presences. Major players in the past year have included Accel India, APG, Bain Capital, Blume Ventures, Chrys Capital, Capital International, IFC, India Quotient, Helion Ventures, Nexus Ventures, SAIF, Inventus Capital Partners, Baring India, Future Ventures, NYLIM India, Ojas Ventures, Pragati Fund, Warburg Pincus, Zodius Capital, Red Fort Cap, Standard Chartered PE, Banyan Tree Growth, KKR, Sequoia Capital India, Ventureast, Intel Capital, DFJ India, NEA IndoUS Ventures, IDG India Ventures, Kleiner Perkins, Norwest Venture Partners and Canaan Partners.
  • In addition to the above, on the domestic level, several players including ICICI Ventures, Kotak, Motilal Oswal, Aditya Birla, Piramal Group continue to make investments in the Indian fund industry. Several leading banks (State Bank of India for example) have tied up with industry players to set up funds of their own.
  • Top global players will look to expand their presence in the Indian fund industry in light of the introduction of the hedge fund category as well.


Issues for domestic funds

  • AIF Regulations: The introduction of the AIF regulations will create new compliance burdens for participants.
  • The advisory side participants in the funds industry will also see additional compliance with the introduction of the Investment Advisor Regulations by SEBI. The Investment Advisors Regulation will cover a larger base of investment advisors, including unregulated investment advisors, sub-advisors etc.
  • There has been some uncertainty on the tax pass-through status being provided to certain categories fund vehicles which are created in the form of private trusts (Category II and Category III AIF). The Income Tax Act, 1961 has not provided an exemption on the taxation of investments made via such structures.
  • Ambiguity on the payment of advance tax. The current taxation regime does not account for income generated by Hedge Funds which are difficult to compute in advance. This will have to be clarified in the days to come.

Issues for offshore funds

  • The Finance Act, 2012 introduced the concept of general anti-avoidance provision (GAAR) under the Income Tax Act, 1961. GAAR is an anti-abuse provision that allows tax authorities to re-characterize income, deny tax treaty benefits and tax certain income at higher than normal rates. GAAR has potential ramifications for offshore funds seeking to invest into India.
  • A large number of funds invest into India via Mauritius, seeking to take advantage of the India Mauritius Double Taxation Avoidance Agreement (Indian Mauritius Tax Treaty). The Indian government is currently seeking to re-negotiate the treaty and in addition, GAAR, intends to deny benefits of the treaty. However, it appears that due to recent developments, including recommendation by an advisory panel to the Government of India, the Mauritius route may be granted some relief in this regard.
  • The Finance Act, 2012 also has introduced some changes in the Income Tax Act, 1961 resulting in possible taxation of income arising from the transfer of shares/ interest in a company/ entity organized outside India, which derives directly or indirectly its value substantially from the assets located in India. This could result in taxes being levied on secondary transfers between investors.
  • New rules have also been introduced under the Income Tax Act, 1961 requiring the furnishing of specific form of Tax Residency Certificates (or TRCs) as prescribed by the Indian tax authorities for availing tax treaty benefits. This could also be an issue.

Laws to be kept in mind

Foreign Exchange Management Act, 1999 and regulations

The Foreign Exchange Management Act, 1999 (FEMA) in conjunction with its underlying regulations essentially regulates various aspects of exchange control. Further, various regulation govern the method of investments, maximum and minimum pricing of assets acquired and disposed of and regulation on rights etc. Relevant regulations and rules in this regard are -

  • The Foreign Direct Investment (FDI) Policy issued annually by the DIPP, Ministry of Commerce and Industry governing foreign investments into India.
  • Foreign Exchange Management (Transfer or issue of security by a person resident outside India) Regulations, 2000.
  • Foreign Exchange Management (Transfer or Issue of Any Foreign Security) Regulations, 2004.

Securities and Exchange Board of India (SEBI) Act, 1992 and regulations

The Act, in conjunction with its underlying regulations essentially outlines the regulation with regard to the securities market in India, both primary and secondary. Certain regulations of importance are listed below:

  • SEBI (Alternative Investment Funds) Regulations, 2012.
  • SEBI (Foreign Institutional Investors) Regulations, 1995.
  • SEBI (Mutual Funds) Regulations, 1996
  • SEBI (Portfolio Managers) Regulations, 1993.
  • SEBI (Prohibition of Insider Trading) Regulations, 1992.
  • SEBI (Substantial Acquisition of Shares and Takeovers) Regulations, 2011.
  • SEBI Issue of Capital and Disclosure Requirements Regulations 2009
  • SEBI (Collective Investment Schemes) Regulations, 1999.

The Prevention of Money Laundering Act, 2005 (PMLA)

As the name suggests, the main objects of the PMLA is to prevent and control activities concerning money laundering and take action in relation to property derived or involved in money laundering.


Income Tax Act, 1961

  • Payment of MAT by offshore funds in the event the tax payable them is less than 18.5% of their book profits.
  • The Government in 2012 has introduced the general anti-avoidance rules, taxation of transfer of assets not situated in India, but having interests assets situated in India (indirect transfer of assets).
  • Requirement of a TRC in the prescribed format for availing tax treaty benefits has been introduced in the year 2012.
  • ITA also includes rules relating to taxation of income arising from international transaction between associated enterprises.
  • Pass through benefits is currently available under the ITA to Category II and III AIFs.


The Reserve Bank of India

  • Established under the Reserve Bank of India Act, 1934.
  • Empowered with regulating inflow and outflow of foreign exchange and formulate related regulations and policies in this regard under the Foreign Exchange Management Act, 1999.

The Securities and Exchange Board of India

  • Established under the Securities and Exchange Board of India Act, 1993.
  • Chief regulator of securities market in India.

Foreign Investment Promotion Board (in case not consistent with the FDI Policy)

  • Established under the Foreign Direct Investment Policy, 2008.
  • Provides single window clearance for matters relating to FDI as well as promoting investment into the country.


  • Bain Capital India Private Equity Report 2012.
  • PWC MoneyTree India Report Q2 2012.
  • PWC MoneyTree India Report Q1 2012.
  • Ernst and Young, Private Equity roundup – India, Q2, 2012.

1 Means the Securities and Exchange of India (“SEBI”)

2 Refer to board mins

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