Introduction
Alternate Investment Funds (“AIFs”), are privately pooled investment vehicles that gather funds from investors for deployment according to a specified investment policy. AIFs in India are regulated by the Securities and Exchange Board of India (“SEBI”) under the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 (“AIF regulations”).
There is a part of AIFs that is inclined toward social welfare Impact Investment Sector, which means investment made in view to gain returns along with the generation of a positive impact on society. The Impact Investment Sector is fragmented among several legislations in India which are responsible for regulating, investing and using the funds which are received for social welfare (Refer here for an in-depth understanding of the interplay between several regulations dealing with impact investing).
One of the major investment vehicles for impact investing in India prior to 2021 was Social Venture Funds (“SVFs”). These are investment vehicles which invest in social ventures with the intent of investing in securities of the ventures that satisfy the norms of social performances laid down by the fund (Refer here to get an in-depth understanding of Social Venture funds). As per AIF regulations, the SVF need to have a corpus of Rs.20 crore for its establishment, with a minimum investment of Rs.1 crore (Refer here for the Report of the working group on Social Stock Exchange). This was a disincentive for the investors as they could barely get returns on their investments even if they wanted to invest in such SVF Funds.Due to such high thresholds and restrictions on muted returns and investment only in social ventures, SVF created low market traction (Refer here to get the impact capital data in India). To tackle these problems, SEBI amended the AIF Regulations via the Securities and Exchange Board of India (Alternative Investment Funds) (Third Amendment) Regulations, 2022, changed Social Venture Fund to Social Impact Fund (“SIF”) Framework.
This article aims to highlight the obstacles faced by foreign investors while investing in SIFs and to create a framework to make an optimal framework for these funds to get legitimate foreign investments.
The article begins by highlighting the lacuna present in the SIF framework due to Foreign Contribution (Regulation) Act, 2010 (“FCRA”). The authors suggest ways to create an interplay between FCRA and SIFs and then propose a whole new framework to optimise the investments in SIFs in a way that also prohibits money laundering and the illegal flow of money in the country. Further, the authors use a cost-benefit analysis of the proposed framework in order to evaluate the efficiency of the proposed framework. Lastly, the authors suggest the way ahead for SEBI and other stakeholders to further strengthen the SIF Framework.
Background of the problem
The SVF framework was established by SEBI so as to bridge the gap between private capital and social ventures. This framework only provided for investments in social ventures which were focused on social benefits and not financial returns. (Refer here for an in-depth analysis of SVFs) )The criteria to classify a fund as SVF was to invest primarily in units of social ventures. It needed to satisfy the social performance norms laid down by the fund, and lastly, its investors must agree to restricted or muted returns.
Under the new framework, SIFs can even invest in Social Ventures as well as Social Enterprises. The amendment decreased the threshold from Rs.20 crore to Rs.5 crore and from Rs.25 lakhs to Rs.10 lakhs. The major change that SEBI made under these regulations is the recognition of the concept of for-profit Social Impact Funds, meaning that now SIFs can invest in even for-profit listed entities which pursue social causes.
The SIFs can issue social units as compared to the previous regime where only issuance of units was for financial returns. The amendment was made with the view to increase the number of social ventures and social enterprises in India, so as to create more social impact in our country, along with the opportunity of gaining financial returns.
Foreign Contribution (Regulation) Act, 2010 and Social Impact Funds
The flow of funds in the country from foreigners is regulated under the Foreign Contribution (Regulation) Act (FCRA), 2010. The primary purpose of FCRA regulation is to regulate the utilisation of foreign contributions by individual associations to keep it consistent with the country’s values. (Section 11 of the FCRA provides that an organisation needs to get specific approval from the Union Home Ministry to receive any kind of foreign contribution.
As per Frequently Asked Questions (“FAQs”) by the Ministry of Home Affairs on FCRA, any kind of infusion of foreign share capital in a company registered under Section 8 of the Companies Act 2013 is considered to be a foreign contribution. (Refer here for a better understanding of FCRA and Section 8 Company) However, the main contention here is that there is no clarity regarding the fact that if a foreign investor invests in an SIF and then an SIF invests in a Section 8 Company, then whether it is to be considered as a foreign contribution or not.
This means that even though the SIFs are purely regulated within the ambit of the SEBI Regulations, the scope of FCRA is wide enough to not allow any SIF to receive any foreign contribution because FCRA allows only non-profit entities to receive the foreign contribution.
This might create a contrasting situation for the SIFs as they are allowed to receive foreign grants under AIF Regulations, but on the other hand, they will not be allowed to receive any such foreign grant or contribution under FCRA. This ambiguity is a cause of concern as this can lead to hampering the investments in SIFs, thereby ultimately reducing the social impact in our country. Therefore, there is a need to create a robust mechanism to prevent this problem.
Way to create an interplay between FCRA and AIF Regulations
Creating an interplay between FCRA and AIF regulations is crucial for attracting more impact investment in India. Currently, the provisions of FCRA might create challenges for investors to invest in social enterprises, specifically Section 8 companies, through SIFs. Aligning FCRA and AIF regulations can lead to massive foreign investments for impact investing in India.
To enable such a balance, the authors propose that the Central Government exempt SIFs specifically by exercising its power under Section 50 of FCRA. This would involve modifying the FCRA regulations to allow SIFs to receive foreign contributions without the need for prior approval from the Ministry of Home Affairs. These exemptions will simplify the administrative and financial burdens on social ventures as well as foreign investors, making it easier to raise funds for impact investing.
However, exempting SIFs from FCRA can lead to an increase in tax evasion, money laundering and an influx of illegal funds in India by creating a whole new channel of transactions. This will shift the legislative intent of easing SIFs from attracting more funds for social investments to a channel of tax evasion and money laundering.
Therefore, the authors propose a new framework to ensure the safe flow of foreign funds into social entities. This framework will guarantee transparency and accountability in fund transfers, preventing illegal transactions. The framework will ensure the attraction of more foreign investment on one hand while creating enough checks and balances to restrict the flow of illegal funds into the country.
This article is authored by Arihant Sethia and Siddhant Singhi, Fourth-year law students at Gujarat National Law University. For – Part II
