Chapter 8: Valuation in Category III Alternative Investment Funds — Part 4: Registered Valuers, Compliance Framework, and Practice Questions

8.4 Third-Party Registered Valuers and Regulatory Framework

To ensure that the valuation of assets in a Category III Alternative Investment Fund (AIF) is unbiased, transparent, and accurate, SEBI mandates that specific asset classes must be valued by an independent registered valuer. This requirement serves as an essential check and balance, separating the asset valuation process from the investment management team's performance metrics.

Under SEBI regulations, a Category III AIF must compulsorily appoint an independent valuer to conduct the valuation of its unlisted securities and listed debt securities.

SEBI's Modernised Valuation Framework (Ind AS Alignment)

In accordance with SEBI Circular No. SEBI/HO/AFD/PoD-1/P/CIR/2024/123 (dated September 19, 2024), SEBI modified the eligibility criteria and operational framework for independent third-party registered valuers to strengthen the credibility of alternative asset portfolios.

1. General Independence & Experience Criteria

• No Mutual Affiliation (Associate Rule): The independent valuer appointed by the fund must not be an "associate" of the Investment Manager, the Sponsor, or the Trustee of the Category III AIF. This ensures there are no conflicting financial interests or corporate cross-holdings that could compromise the valuer's objectivity.
• Track Record Constraint: The independent valuer must possess a minimum of three (3) years of active experience in the valuation of unlisted securities.

2. Specific Eligibility Criteria for Individual Valuers

An individual professional seeking to act as an independent valuer for a Category III AIF must satisfy at least one of the following eligibility benchmarks:

• Dual Registration & Professional Qualification: The valuer must be officially registered with the Insolvency and Bankruptcy Board of India (IBBI) and must hold an active membership in at least one of the following premium professional bodies:
  • The Institute of Chartered Accountants of India (ICAI)
  • The Institute of Company Secretaries of India (ICSI)
  • The Institute of Cost Accountants of India (ICMAI)
  • Alternatively, the valuer must hold a CFA Charter issued by the CFA Institute.
• Credit Rating Agency Subsidiary Status: The valuer can be structured as a holding company or a direct subsidiary of a Credit Rating Agency (CRA) registered with SEBI.
• Discretionary SEBI Fitment: The valuer must satisfy any other alternative criteria that may be specified or updated by SEBI from time to time.

3. Eligibility Criteria for Partnership Entities and Corporate Valuer Entities

If a Category III AIF appoints a partnership firm or a corporate entity to handle its valuation requirements, the entity must comply with the following structural rules:

• IBBI Entity Registration: The partnership or corporate entity itself must be registered as a Registered Valuer Entity with the Insolvency and Bankruptcy Board of India (IBBI).
• Sign-off Authority & Personnel Qualifications: The specific deputed or authorised person(s) within that Registered Valuer Entity who physically undertake and sign off on the valuation of the AIF's portfolio must independently hold a membership of ICAI, ICSI, ICMAI, or hold a CFA Charter.

8.4.2 Valuation Compliance, Governance, and Reporting

Valuation governance is a continuous compliance function. It is subject to strict regulatory disclosure and audit protocols to protect investors from stale asset pricing or arbitrary portfolio markups.

1. The Investment Manager's Ultimate Fiduciary Responsibility

While an independent valuer performs the physical mathematical calculations, the Investment Manager remains solely and ultimately responsible for ensuring a "true and fair" valuation of the Category III AIF's underlying investments.

• Stewardship Code Alignment: Under the regulatory Code of Conduct, the Investment Manager is legally obligated to provide appropriate, well-considered, and accurate inputs to the valuer to enable a proper valuation of the portfolio. The manager is prohibited from providing misleading data or withholding known negative facts about investee companies.
• Valuation Guideline Endorsements: Domestic AIF industry associations are tasked with endorsing standardized valuation guidelines. These guidelines must systematically integrate the recommendations of SEBI’s Alternative Investment Policy Advisory Committee (AIPAC).

2. Mandatory Disclosures in the Private Placement Memorandum (PPM)

A Category III AIF must provide a comprehensive, transparent breakdown of its valuation policies within its PPM. This includes:

• Asset-Class Specific Methodology: The PPM must outline the exact valuation approach (e.g., closing market price, amortized cost, or independent FMV model) adopted for each specific asset class in the scheme.
• Disclosing Accounting Policy Changes: If there are any subsequent changes to the fund's or investee company's accounting practices or policies, the manager must immediately disclose:
  • Detailed descriptions of the changes in accounting policies/practices.
  • A clear calculation of the financial impact of these changes on the valuation of the AIF scheme's investments.

3. Compliance Test Reporting (CTR) and Audit Validation

The calculation and dissemination of the NAV is subject to an annual audit by a qualified auditor. The Investment Manager must verify compliance via the annual Compliance Test Report (CTR) submitted to the Trustees and Sponsors, which checks:

• Functional Independence: Verification that the calculation of the NAV is kept completely separate and independent from the fund management function of the AIF.
• Disclosure Frequency Compliance: Confirmation that the NAV is disclosed to investors at quarterly intervals for closed-ended schemes and at monthly intervals for open-ended schemes.
• Standardization Adherence: Audit confirmation that the fund has consistently applied a standardized approach for asset valuation in accordance with SEBI guidelines.

8.5 Chapter 8 Practice Sample Questions and Answers

To prepare candidates for the NISM Series XIX-B Certification Examination, this section provides a detailed analysis of the official Chapter 8 sample questions.

Question 1

Which of the following positions in F&O are eligible to be considered as offsetting positions, to compute the maximum permissible Leverage for a Category III AIF?

• A. A Call Option and a Put Option on a different underlying asset, but with the same strike price
• B. A Call Option and a Put Option on the same underlying asset, but with different strike price
• C. A Long Futures Contract and a Call option on the same underlying asset
• D. A Long Futures Contract and a Put option on a different underlying asset

Correct Answer: B. A Call Option and a Put Option on the same underlying asset, but with different strike price

Grounded Explanation: To calculate "Total Exposure" for leverage compliance, SEBI permits funds to offset opposite positions only if they have the exact same underlying stock, index, or commodity asset. Because Options bought on different underlying assets do not share the same systematic risks, they cannot be offset. An opposite call and put option on the same underlying asset with different strikes represents a valid vertical or horizontal spread that reduces net portfolio exposure.

Question 2

A Category III AIF is permitted to trade in Commodity Derivatives contracts up to a limit of 10 percent of its investable funds in one underlying commodity. State whether True or False.

• A. True
• B. False

Correct Answer: A. True

Grounded Explanation: In accordance with the regulatory permissions outlined by SEBI, Category III AIFs are permitted to participate in the commodity derivatives market. However, to prevent concentration risk in any single physical asset, the fund's total exposure in commodity derivative contracts is legally capped at 10 percent of its overall investable funds in any single underlying commodity.

Question 3

Which of the following securities would least likely be valued at Fair Market Value, by a Category III AIF?

• A. Listed Equities
• B. Unlisted Equities
• C. Exposure in Commodity Derivative Contracts
• D. Units of a mutual fund

Correct Answer: D. Units of a mutual fund

Grounded Explanation: Under Indian Accounting Standards (Ind AS) and SEBI guidelines:

• Listed equities are valued directly at closing market prices on stock exchanges.
• Unlisted equities must be valued at Fair Market Value (FMV) determined by an independent registered valuer.
• Derivatives are marked-to-market using settlement prices or standard models.
• Units of a mutual fund are structurally unique; their value is derived directly from the last net asset prices (NAV) published by the managers of those respective mutual funds as of the Valuation Day, rather than through independent fair market value models.

Question 4

_________ is computed for investors in a series of units to report the value of assets attributable per unit, as reduced by the liabilities and expenses apportioned to such series, as on a Valuation Day.

• A. Fund NAV
• B. Class NAV
• C. Series NAV
• D. Series Assets

Correct Answer: C. Series NAV

Grounded Explanation: The Series NAV is calculated specifically for a single series of units within a broader class. It is mathematically derived by taking the Series Assets, deducting all Series-specific liabilities and expenses (such as the class-specific management fee and accrued performance incentive fee), and dividing by the total number of units issued under that specific series. This process ensures that investors are charged only the expenses agreed to in their specific contracts.

8.6 Chapter 8 Master Glossary & Summary

• Independent Valuer: A qualified valuer registered with the IBBI who is not an associate of the AIF’s sponsor, manager, or trustee, and has at least 3 years of experience in valuing unlisted securities.
• Registered Valuer Entity: A partnership firm or corporate entity registered with the IBBI, whose authorised members hold professional certifications from ICAI, ICSI, ICMAI, or the CFA Institute.
• AIPAC: The Alternative Investment Policy Advisory Committee of SEBI, which provides recommendations on valuation guidelines and regulatory standards for alternative investments.
• CTR (Compliance Test Report): A mandatory annual report prepared by the Investment Manager to verify compliance with valuation independence, disclosure frequency, and SEBI-specified standardization approaches.
• Off-Balance Sheet Exposure: Exposure taken in leveraged derivative contracts that do not represent a direct physical asset purchase on the balance sheet but pass all associated risks and returns to the fund.