Special Situations Funds are a new subcategory of AIFs introduced by SEBI (2024)

BIAT Consultant

In its last board meeting on December 28, 2021, the Securities and Exchange Board of India (SEBI) launched a Special Situations Fund like a different sub of Category I Alternative Investment Funds (AIFs) under the SEBI (AIF) Regulations, 2012.

(Amendment Regulations). Following the Board meeting, SEBI published the SEBI (AIF) (Amendment) Regulations, 2022 on January 24, 2022, that added Chapter III-B — Special Situations Fund to the SEBI (AIF) Regulations, 2012 (SEBI Regulations), which regulates Special Situations Fund.

SEBI’s move follows a series of the government’s increasing attempts to save enterprises in the banking crisis.

What is a ‘Special Situations Fund,’ and how does it work?

A special situations fund follows an asset allocation in which it tries to profit from a unique market condition that has the potential to boost the value of an investment in the coming years.

When an individual detects an opportunity to invest ahead of time that has the potential to grow in price in the coming years and executes an investment choice in that direction, a unique situation occurs. Investing in such chances is the subject of Special Situations schemes. Typically, such funds invest in stocks.

What adjustments has SEBI made as a result of the Amendment Regulations?

Special Situations Fund is a new class within Category — I Alternative Investment Fund, according to the Amendment Regulations (AIF). These Special Situations Funds would only invest in special circ*mstance properties that meet their financial goals, and they might also serve as a resolution candidate under the Insolvency and Bankruptcy Code of 2016, if necessary (IBC). Below are the modifications made as a result of the Amendment Regulations:

A Special Situations Fund must be registered.

A candidate must qualify as a Special Situations Fund following the rules of Chapter II of the AIF Regulations to be considered. The Special Situations Funds and the programs they develop are the subjects of Chapter II.

The IBC’s eligibility criteria for a Special Situations Fund

To function as a resolution candidate, a Special Situations Fund must meet the IBC’s eligibility conditions and necessary compliances for resolution applicants, which would then enable the Special Situations Fund to join in the IBC’s resolution procedure.

Only invest in Special Situation Assets.

The Special Situations Funds are only allowed to invest in special circ*mstance resources,’ per the Amendment Regulations, which include the reading:

Stressed loans which are accessible for acquiring under Clause 58 of the Reserve Bank of India (Transfer of Loan Exposures) Directions, 2021 (Transfer of Loan directions), as modified from periodically, or
Assets that are a part of the IBC-approved resolution plan or
Following any policy issued by the RBI or the Government of India in this respect,
The Asset Reconstruction Companies (ARCs) or the Special Situations Fund have the authority to invest in security receipts issued by them.
Securities issued by distressed Investee companies or
Any other asset or security that the Board may recommend in this respect from periodically

The letter indicates the following in regards to Special Situations Funds purchasing stressed loans under Clause 58 of the Transfer of Loan instructions:

If the Transfer of Loan Directions allows it, the Special Situations Funds could obtain stressed loans.
The Special Situations Fund’s participation in any of the stressed loans approved by the Transfer of Loan Directions is subjected to a six-month minimum lock-in term. It should be emphasized that if the stressed loan is recovered from the borrower, the lock-in term would be nullified.
Special Situations Funds that receive stressed loans according to the Acquisition of Loan Directions must conduct the same kind of investigative work on their investors as the RBI requires of investors in Asset Reconstruction Companies.

Investment requirements for the Special Situations Fund

SEBI has stipulated that each Special Situations Fund scheme should have a capital of at least 100 crore rupees, per the Amendment Regulations. Apart from Special Situations Funds, Special Situations Funds are not permitted to accept investments from other AIFs. An investor would invest a minimum investment of 10 crore rupees in a Special Situations Fund, while authorized investors could maintain a minimum investment of 5 crore rupees. The minimum amount of investment needed is Rupees 2.5 crores in the event of workers or directors of the Special Situations Fund or workers or directors of the money manager.

At the time of investment, flexibility was granted.

The Alternative Investment Policy Advisory Committee suggested the Special Situations Fund’s framework (AIPAC[1]). AIPAC examined Regulations 15(1)© and 16(1)(a) of the AIF Regulations when making its recommendation. Regulation 15(1)© states that an AIF may not invest more than 25% of its investible funds in any one company or AIF.

On the other hand, Regulation 16(1)(a) requires subcategories of Category I AIFs to invest at least 75% of their investable capital in unregistered securities of investee businesses. Because the Special Situations Fund does not have pre-defined strategies for diverse assets, AIPAC believes that the aforementioned compliances would be impossible to achieve.

To save the corporation, they must buy distressed assets. As a result, Special Situations Funds have been granted exemptions and flexibility, such that Regulation 15(1)(a) would not apply to them, and they would not be required to invest a particular segment of their investible funds in unregistered stocks.

SEBI has eased the investment restrictions imposed under Regulation 15(1)© and Regulation 16(1)(a) of the AIF Regulations for Special Situations Funds in light of the aforementioned circ*mstances.

Investment restrictions for the Special Situations Fund

Investments in the following categories are prohibited for the Special Situations Funds:

1. It would not invest in any of its affiliates or any other Alternative Investment Fund’s units. They have, meanwhile, been granted an exception, allowing them to invest in the units of another Special Situations Fund.

2. They are also prohibited from participating in units of the Special Situations Fund sponsored and managed by any of the fund’s sponsors, managers, or affiliates.

Conclusion

SEBI’s modifications to Special Situations Funds provide yet another mechanism for fund managers and investors to aggregate their services to help distressed enterprises turn around. This would benefit companies not only in bankruptcy procedures but also outside of them, as investors and fund managers would now be able to bring in specialized pooled vehicles with experience in turning around stressed assets.

They would, in turn, invest in troubled assets long before the company went bankrupt. This would eventually boost the success rate of rescuing troubled enterprises although such operations would be carried out outside the scope of court or regulatory oversight and would not be postponed needlessly.