Comprehensive Study Notes: NISM Series XIX-D Category I and II AIF Managers — Chapter 12: Fund Monitoring, Reporting, and Exit (Part 4 of 4)

This is Part 4 of a 4-part comprehensive study notes series for Chapter 12 of the NISM Series XIX-D Certification workbook. This section represents the final segment of Chapter 12 and covers the strict regulatory, operational, and structural processes surrounding the dissolution and terminal stages of an AIF. It covers winding-up procedures, the detailed framework of the SEBI Liquidation Scheme, in-specie distributions, mandatory bid and valuation rules, the Dissolution Period, and terminal performance benchmarking obligations.

1. Winding Up of an Alternative Investment Fund (Regulation 29)

A close-ended Alternative Investment Fund (AIF) cannot operate indefinitely. It is designed to harvest unlisted investments and return capital to its contributors within a pre-defined timeline. Winding up represents the formal process of dissolving the fund vehicle, liquidating its remaining assets, settling its liabilities, and distributing the final proceeds to its investors.

1.1 Statutory Grounds for Winding Up

Under Regulation 29 of the SEBI (Alternative Investment Funds) Regulations, 2012, an AIF must be wound up under any of the following four legal circumstances:

1. Expiry of Tenure: Upon the completion of the fund's defined lifecycle or the tenure of its individual schemes, as specified in the Private Placement Memorandum (PPM).
2. Opinion of the Trustees: If the Trustees or the Trustee Company (for AIFs structured as a Trust) formally determine that the fund should be wound up in the absolute interest of the unit holders.
3. Investor Resolution: If not less than 75% of the investors by value of their total investment in the AIF pass a formal resolution at a meeting of unit holders declaring that the fund be wound up.
4. SEBI Direction: If the Securities and Exchange Board of India (SEBI) explicitly directs the AIF to wind up its operations in the interest of investors or to maintain market integrity.

1.2 Structure-Specific Winding-Up Frameworks

Depending on the constitutional structure adopted by the AIF during its formation, different statutory acts govern the dissolution process:

• Trust Structure: Wound up in accordance with the provisions of the Indian Trusts Act, 1882 and the registered Trust Deed.
• Company Structure: Wound up in accordance with the provisions of the Companies Act, 2013.
• Limited Liability Partnership (LLP) Structure: Wound up in accordance with the provisions of the Limited Liability Partnership Act, 2008.

1.3 Immediate Operational Effect of Winding Up

Once the winding-up process is initiated, the fund's status changes immediately to protect investors from fresh exposures:

• The Investment Manager is strictly prohibited from executing any new investment transactions on behalf of the AIF.
• The fund must focus exclusively on liquidating its current portfolio holdings and distributing the terminal proceeds.
• The Sponsor or Trustee must formally intimate SEBI and the fund's investors of the winding-up trigger, detailing the conditions under which the winding up will be carried out.

1.4 The Winding-Up Liquidation Period

• Duration: The standard "Liquidation Period" is 1 year following the formal expiry of the fund's tenure or its extended tenure.
• Mandate: During this 1-year window, the Investment Manager must make best efforts to fully liquidate the remaining assets of the close-ended scheme.
• Unliquidated Assets Dilemma: If the manager is unable to sell certain illiquid assets due to a lack of market liquidity, they must adopt one of three regulatory alternatives before the Liquidation Period expires:
  1. Distribute the unliquidated assets in-specie to the investors.
  2. Transfer the assets to a Liquidation Scheme (under Regulation 29A).
  3. Enter into a formal Dissolution Period.

2. The SEBI Liquidation Scheme Framework (Regulation 29A)

To prevent AIFs from being forced to write off highly illiquid assets at a nominal value upon fund expiry, SEBI introduced Regulation 29A, which established a specialized structural vehicle known as the "Liquidation Scheme".

2.1 Characteristics and Operational Rules

A Liquidation Scheme is a separate close-ended scheme launched exclusively to house and resolve the unsold, illiquid investments of an expiring AIF scheme (referred to as the "Original Scheme").

• Naming Convention: The scheme's name must compulsorily incorporate the words "Liquidation Scheme" to ensure absolute transparency.
• Regulatory Filing: The manager must file a separate Private Placement Memorandum (PPM) for the Liquidation Scheme with SEBI through a registered Merchant Banker.
• Strict Prohibitions:
  • The scheme cannot accept any fresh capital commitments from any investor.
  • The scheme cannot make any new portfolio investments in other companies.
  • No standard "Liquidation Period" is allowed to a Liquidation Scheme upon its own expiry.
• Tenure Restrictions: The tenure of the Liquidation Scheme is determined and locked at the time of filing its PPM and is strictly non-extendable.

2.2 The Asset Transfer and Unit Distribution Mechanics

1. Investor Approval: Transferring unliquidated investments from the Original Scheme to the Liquidation Scheme requires the formal consent of at least 75% of the investors by value of their investment in the Original Scheme.
2. Transaction Timing: The Liquidation Scheme must be launched, the assets transferred, and the Original Scheme wound up prior to the expiry of the standard 1-year Liquidation Period of the Original Scheme.
3. Unit Swapping: Upon receiving the units of the newly formed Liquidation Scheme, the Original Scheme must mandatorily distribute these units in-specie to its investors in proportion to their holdings, in lieu of their original units.

2.3 The April 25, 2024 SEBI Amendment

• Crucial Regulatory Sunset: SEBI amended the AIF Regulations to state that no registered AIF shall launch any new Liquidation Schemes post April 25, 2024.
• Alternative Path: For funds expiring after this date, managers must utilize either the In-Specie Distribution route or transition into a formal Dissolution Period to resolve unliquidated holdings.

3. In-Specie Distribution of Unliquidated Investments

When an AIF is wound up and has unliquidated, illiquid holdings, it can choose to distribute the physical shares or debt instruments directly to the investors' demat accounts, rather than selling them.

3.1 Voluntary In-Specie Distribution

• Requirement: This requires the formal approval of at least 75% of the investors by value of their investment in the existing AIF scheme.
• Process: The physical assets (such as unlisted shares, compulsorily convertible preference shares, or debt debentures) are transferred directly into the individual demat accounts of the consenting investors.

3.2 Mandatory In-Specie Distribution

If the Investment Manager is unable to obtain the requisite 75% investor consent for either a Liquidation Scheme, a voluntary in-specie distribution, or a Dissolution Period, the fund faces a mandatory resolution trigger:

• The unliquidated, unsold investments of the scheme must be mandatorily distributed to the investors in-specie.
• If any individual investor is unable or unwilling to accept these unlisted securities (due to internal institutional mandates or regulatory restrictions), the investment manager is authorized to write off the asset value to zero for that specific investor, and the units will be closed.

4. Mandatory Bid Requirements and Valuation Rules

To prevent valuation manipulation and protect dissenting investors during asset transfers to a Liquidation Scheme or during in-specie distributions, SEBI enforces strict bid discovery rules.

4.1 The 25% Bid Mandate

• Discovery Rule: Prior to executing an asset transfer to a Liquidation Scheme or distributing assets in-specie, the Investment Manager must arrange a binding bid for a minimum of 25% of the total value of the unliquidated investments.
• Consolidated Bidding: Bids must be obtained for units representing the consolidated, combined value of each unliquidated investment in the Original Scheme's portfolio, rather than on an isolated basis.
• Disclosure: The bid values discovered, alongside the valuations carried out by two independent registered valuers, must be fully disclosed to all investors of the Original Scheme.

4.2 Protection and Exit Option for Dissenting Investors

• The Cash Exit Pathway: Dissenting investors of the Original Scheme (those who vote against the asset transfer or the in-specie distribution) must be provided with a formal option to fully exit the scheme.
• Funding the Exit: This cash exit is funded entirely out of the 25% bid arranged by the Investment Manager.
• Surplus Allocation: After the dissenting investors have been fully paid out, any remaining, unsubscribed portion of the 25% bid is used to provide a pro-rata cash exit to the non-dissenting investors.
• Related Party Exclusion: If the bidder or any of their related parties (as defined under SEBI LODR Regulations) are also investors in the Original Scheme, they are strictly prohibited from obtaining an exit from the fund using the arranged bid.

4.3 Asset Transfer and Distribution Valuation Rules

The value at which unliquidated investments are transferred to a Liquidation Scheme or distributed in-specie is determined by whether the manager successfully arranged the mandatory 25% bid:

• Case A: Bid Arranged: If the manager successfully arranges a bid for a minimum of 25% of the value of the unliquidated assets, the investments are transferred or distributed at the actual Bid Value.
• Case B: Bid Fails: If the manager fails to arrange a minimum 25% bid, the assets are transferred or distributed at a nominal value of One Rupee (INR 1). The remainder of the book value must be written off, which negatively impacts the manager's reported track record.

5. The Dissolution Period Framework

With the sunset of new Liquidation Schemes, transitioning into a formal Dissolution Period has become the primary regulatory mechanism to resolve unliquidated assets at the end of the 1-year Liquidation Period.

5.1 Definition and Scope

The Dissolution Period represents an extended phase following the expiry of the standard 1-year Liquidation Period, allowed solely for the purpose of liquidating the remaining unsold investments of an expiring AIF scheme.

5.2 Key Regulatory and Procedural Requirements

• Investor Consent: Entering a Dissolution Period requires the formal approval of at least 75% of the investors by value of their investment in the existing scheme.
• SEBI Filing: The scheme must file an Information Memorandum along with a Due Diligence Certificate prepared by a registered Merchant Banker with SEBI.
• Filing Timeline: The filing must be completed and submitted to SEBI before the expiry of the 1-year Liquidation Period or any permitted extension.
• Strict Structural Limits:
  • The Dissolution Period cannot exceed the original tenure of the scheme.
  • It is strictly non-extendable under any circumstances.
  • The fund cannot accept any fresh capital commitments from investors.
  • The fund cannot execute any new portfolio investments during this period.

5.3 Mandatory Disclosures Prior to Seeking Consent

Before a manager can seek the 75% investor consent to transition into a Dissolution Period, they must provide a detailed disclosure package to all unitholders:

1. Tenure and Asset Details: The proposed duration of the Dissolution Period and a granular list of all remaining unliquidated investments.
2. Value Recognition: The exact value at which these unliquidated assets will be recognized and reported to Performance Benchmarking Agencies.
3. Independent Valuations: An indicative range of the asset values based on independent valuation reports conducted by two registered independent valuers, alongside an indicative range of prospective bid values.

6. Performance Benchmarking and Future PPM Disclosures

Even during winding up and asset dissolution, AIFs must adhere to strict performance reporting and benchmarking standards to ensure market transparency and prevent historical performance manipulation.

6.1 Reporting to Benchmarking Agencies

The Investment Manager must report the terminal valuations of unliquidated assets to SEBI-registered Performance Benchmarking Agencies in a timely manner.

• For Liquidation Schemes: The manager must report the exact value of the sale of unliquidated investments to the Liquidation Scheme.
• For In-Specie Distributions: The manager must report the exact value at which the in-specie distribution was executed (which will be the Bid Value, or a nominal One Rupee if the 25% bid was not arranged).
• This ensures that any write-downs or failure to secure bids (such as assets valued at One Rupee) are accurately reflected in the manager's public performance track record and GIPS-compliant disclosures.

6.2 Successor Fund Disclosures

• The Investment Manager is legally required to make clear, prominent disclosures regarding these unliquidated assets, their ultimate resolution values, and any write-offs in the PPMs of all subsequent schemes launched by the manager.
• This prevents managers from hiding asset-level failures of expired vintage funds when pitching new schemes to prospective institutional allocators.

6.3 Fund-of-Funds (FoF) Double Pass-Through Rules

• Scenario: If an AIF scheme (Fund Alpha) has invested capital in the units of another underlying AIF scheme (Fund Beta), and Fund Beta launches a Liquidation Scheme or enters a Dissolution Period, a double pass-through rule is triggered.
• Mandate: Upon the expiry of its own tenure or extended tenure, Fund Alpha must mandatorily distribute the units of Beta's Liquidation Scheme in-specie to its own ultimate investors. This ensures that illiquid exposures are passed back to the ultimate beneficiaries without creating nested structures.

7. Key Terms and Exam-Relevant Summary

7.1 Summary of Core Terminal Concepts

7.2 Practical Application Scenario

Scenario: Liquidation Dilemma of an Infrastructure AIF

• Context: "Sigma Asset Fund" is a close-ended Category I Infrastructure AIF. The fund has completed its 7-year tenure plus a 2-year extension as of 31st May 2026. The 1-year standard Liquidation Period is ending on 31st May 2027. The fund has one remaining asset: a 15% unlisted equity stake in an operational toll bridge company, valued at INR 100 Crore. The manager wants to transfer this asset to a Dissolution Period.
• Question: What are the statutory steps and valuation rules the manager must comply with under SEBI regulations?
• Analysis and Process:
  1. Consent: The manager must obtain the formal approval of at least 75% of the investors by value to enter a Dissolution Period.
  2. Filing: Before 31st May 2027, the manager must file an Information Memorandum and a Due Diligence Certificate prepared by a Merchant Banker with SEBI.
  3. Disclosures: Prior to the investor vote, the manager must disclose the proposed tenure of the Dissolution Period, independent valuations from two independent registered valuers, and an indicative bid range.
  4. Bid Discovery: To avoid writing down the asset to a nominal value of One Rupee, the manager must arrange a binding third-party bid for at least 25% of the asset's value (i.e., a bid of at least INR 25 Crore).
  5. Dissenting Investors: Any investor who votes against the Dissolution Period must be offered a cash exit option funded out of this arranged 25% bid. If the bidder is an existing investor or related party, they cannot use the bid to exit the scheme.
  6. Performance Record: If the manager successfully secures the bid, the asset transitions into the Dissolution Period at the discovered Bid Value. If they fail to secure a 25% bid, the asset is valued at One Rupee, and the manager must disclose this massive write-down in the PPMs of all successor schemes.