Valuation of AIF

In order to curb the flexibility in the valuation techniques, and avoid variances and non-uniformity due to adoption of different valuation methodologies which may provide AIF (Alternate Investment Funds) to distort the valuation and provide a wide range of values and space for the AIF's to interplay with the valuation which may lead to manipulated results, the SEBI has provided the amendment in the regulations to make it more specific and standardized. Also, in the previous scenario there was no proper channel or modalities for the proper reporting of the valuation and further no disclosure was there in the Private Placement Memorandum (PPM).

Effective Date & Applicability:
SEBI issued “The Standardized approach to valuation of investment portfolio of Alternative Investment Funds (AIFs)” circular on 21st June, 2023 however the provisions of the same shall come into force with effect from November 01, 2023. Hence, the applicability of this provisions shall commence w.e.f. November 01, 2023 i.e. all the Alternative Investments Funds shall be required to obtain the valuation in regards or reference to the circular as per SEBI and through a Registered Valuer.

Manner of Valuation of AIFs Investments: In terms of the Regulation 23(1), AIFs are inter-alia required to carry out the valuation of investments in the manner specified by the SEBI from time to time. The manager shall also disclose in Private Placement Memorandum (PPM), the details of the valuation methodology and approach adopted under the stipulated guidelines for each asset class of the scheme of the AIF.

A. Norms for Valuation of securities :

Valuation of securities for which valuation norms have already been prescribed under SEBI (Mutual Funds) Regulations, 1996 (‘Mutual Fund Regulations’), shall be carried out as per the norms prescribed under the said Regulations. SEBI has specified the manner of valuation according to which, the securities whose valuation norms have already been prescribed under Eighth Schedule of SEBI (Mutual Funds) Regulations, 1996, shall be valued as per the norms prescribed therein.

Valuation Guidelines for which valuation norms have already been prescribed under SEBI (Mutual Funds) Regulations,1996:

Traded and non-traded securities: Traded securities other than money market and debt securities are required to be valued at the last quoted closing price on the stock exchange while the non-traded securities are to be valued “in good faith” by the Asset Management Company (AMC) on the basis of appropriate valuation methods based on the principles approved by the Board of the AMC. These principles require the equity instruments to be valued on the basis of capitalization of earnings solely or in combination with the net asset value, using for the purposes of capitalization, the price or earnings ratios of comparable traded securities and with an appropriate discount for lower liquidity. Accordingly, both DCF (Income Approach) and NAV (Asset Approach) may be applied for the purpose of valuation.
Convertible securities: For convertible debentures and bonds, the non-convertible portion should be valued on the same basis as would be applicable to a debt instrument while for the convertible portion, the valuation should be done in the same way equity instruments are valued. Accordingly, the equity portion should be valued based on the basis of underlying security of equity valuation in the ratio of conversion value.
Rights shares: Until rights shares are traded they should be valued as no. of rights offered divided by the no. of original shares held multiplied by the difference between Ex-rights price and rights offer price. For Example if 10 rights were offered while already holding 100 shares at a rights offer price of say, Rs. 30 and the Ex-rights price is determined to be Rs. 35 then the value of rights shall be = 10/100*( 35-30 ) which is equal to 0.5.
However, in case a decision is made not to subscribe to the right shares but to renounce them and these renunciations are traded, the renunciation value shall be taken into account.

Valuation of Other Securities
Valuation of securities which are not covered in the “Securities whose valuation norms have already been prescribed under Eighth Schedule of SEBI (Mutual Funds) Regulations, 1996”, shall be carried out as per valuation guidelines endorsed by any AIF industry association, which in terms of membership represents at least 33% of the number of SEBI registered AIFs. The eligible AIF industry association shall endorse appropriate valuation guidelines after taking into account recommendations of Alternative Investment Policy Advisory Committee of SEBI.

B. Responsibility of Manager of AIFs with regard to Valuation of investments of AIF
According to Regulation 23(5) of AIF Regulations, the Manager and the key management personnel of manager shall ensure that the independent valuer computes and carries out valuation of the investments of the scheme of the AIF in the manner as specified by the Board from time to time.
Further, according to Regulation 23(6) of AIF Regulations, Manager shall be responsible for true and fair valuation of the investments of the scheme of the AIF. In terms of proviso to aforesaid Regulation, in case the established policies and procedures of valuation do not result in fair and appropriate valuation, the Manager shall deviate from the established policies and procedures in order to value the assets or securities at a fair value and document the rationale for such deviation.

Deviations And Changes Requiring Disclosure

At each asset level, in case there is a deviation of more than 20% between two consecutive valuations or a deviation of more than 33% in a financial year, the manager shall inform the investors the reasons/factors for the same, both generic and specific, including but not limited to changes in accounting practices/policies, assumptions/projections, valuation methodology and approach, etc. and reasons thereof.
Any change in the methodology and approach for valuation of investments of scheme of AIF, shall be construed as material change significantly influencing the decision of the investor to continue to be invested in the scheme of the AIF. The manager shall disclose the following as part of changes in PPM to be submitted annually to SEBI and investors:

Details of changes in the valuation methodology and approach, if any, for valuation of each asset class of the scheme of the AIF;
Details of changes in accounting practices/policies, if any, of the investee company and the scheme of the AIF; and
Details of impact of the aforesaid changes in terms of valuation of the investments of the scheme of the AIF.

C. Eligibility Criteria for Independent Valuer

The independent valuer shall not be an associate of manager or sponsor or trustee of the AIF i.e. the valuer should be independent from the AIF.
The independent valuer shall have at least three years of experience in valuation of unlisted securities.
The independent valuer shall fulfil one of the following criteria:

The independent valuer is a valuer registered with Insolvency and Bankruptcy Board of India (IBBI Registered Valuer) and has membership of Institute of Chartered Accountants of India or Institute of Company Secretaries of India or Institute of Cost Accountants of India or CFA Institute; or
The independent valuer is a holding company or subsidiary of a Credit Rating Agency registered with SEBI; or
Any other criteria as may be specified by SEBI from time to time.

Our entity R&A Valuation LLP is an IBBI Registered Valuer entity, also Abhinav Rajvanshi is independent valuer registered with Insolvency and Bankruptcy Board of India and has membership of Institute of Chartered Accountants of India or Institute of Company Secretaries of India.

D. Reporting of valuation of investments to performance benchmarking agencies
Manager of AIF shall ensure that a specific timeframe for providing audited accounts by the investee company to the AIF is included as one of the terms in subscription agreement / investment agreement with the investee company, so as to enable AIFs to report valuation based on audited data of investee companies as on March 31 to performance benchmarking agencies within the specified timeline of six months. Manager of AIF shall ensure that valuation based on audited data of investee company is reported to performance benchmarking agencies only after the audit of books of accounts of the AIF in terms of Regulation 20(14) of AIF Regulations, within the stipulated timelines. The manager of AIF shall submit report on compliance with the provisions of this circular on SEBI Intermediary Portal (www.siportal.sebi.gov.in) in the format as specified therein.

As stated the valuation report or valuation data shall be based on the Audited Financials/Accounts of companies in which investments have been made by the AIF (Alternate Investment Fund) or investee companies for the year ended date. Further the valuation reports shall be submitted to the benchmarking agencies within 6 months.

The Standardised Approach to valuation of investment portfolio of alternative investment funds (AIFs) with regards to valuation of investments is one of the steps to ensure the true and fair disclosure of value of investment portfolio. Also, it ensures that the valuation principles/practices/methodology are in uniformity across the AIF industry.

As a culmination of that exercise, SEBI in its board meeting held on 30 March 2023 (SEBI Board Meeting) has announced several decisions in relation to fund management and operations of, inter alia, Alternative Investment Funds (AIFs) by approving amendments to the SEBI (Alternative Investment Funds) Regulations, 2012 (AIF Regulations). These decisions have been released to the public through the press release PR No. 6/2023 (Press Release) and the amendment regulations should follow shortly. The relevant contents of the Press Release, pertaining to AIFs have been summarised below.

Standardisation of Valuation Approved Amendment: SEBI, through the Press Release, has approved to amend the AIF Regulations to codify a framework for valuation of investments by AIFs and to also stipulate eligibility criteria for independent valuers engaged to conduct the valuation. The requirement for conducting valuation is also proposed to be extended to investments by Category III AIFs in unlisted securities and listed debt securities. It has been clarified that the responsibility to undertake true and fair valuation would vest on the manager of the AIF. Purpose: SEBI has stated that the purpose of the proposed amendments is to provide guidance to AIFs towards a consistent and standardised approach for valuation of their investment portfolios. SEBI had, through its circular dated 5 February 2020, stipulated the standardised template for private placement memorandum (PPM) to be followed by AIFs, which required inclusion of a separate section on valuation and prescribed the details to be disclosed under the same, including valuation principles used by the AIF and other guiding principles relevant for investors to know with respect to valuation of the AIF. Regulation 23(1) of the AIF Regulations also requires AIFs to provide to its investors a description of its valuation procedure and methodology of valuing assets. The approved amendment is pursuant to the consultation paper on ‘Standardised approach to valuation of investment portfolio of Alternative Investment Funds’ issued on 06 January 2023 by SEBI (Consultation Paper on Valuations), wherein the regulator observed that while managers of AIFs have flexibility to adopt any valuation principle / methodology / standard by disclosing the same to investors in PPMs, presently, the modalities are not disclosed and not reported to SEBI subsequently. The Consultation Paper on Valuations also noted that the Alternative Investment Policy Advisory Committee (AIPAC), in its meeting held on 11 October 2022 and 22 November 2022, specified International Private Equity and Venture Capital Valuation Guidelines (IPEV Guidelines) as a standard for valuing investment portfolio of private equity / venture capital funds in various jurisdictions. While disclosures are healthy for the market and beneficial to investors, which is already a requirement under the AIF Regulations and the standardised template PPM, laying out a framework for conducting the valuation process or identifying IPEV Guidelines as the required valuation methodology for valuation would make the process over prescriptive and remove the flexibility necessary for managers to conduct valuation based on the specific strategy and considerations applicable to a particular AIF, as one size fits all cannot be the solution. For example, a credit / debt fund may not opt for IPEV Guidelines as it is more suited for private equity strategy. However, much would depend on the content of such framework.
Value of unliquidated investments in track record of manager and reporting by performance benchmarking agencies Approved Amendment: SEBI has approved the amendment to require the value of unliquidated investments of an AIF being transferred to a liquidation scheme or distributed inspecie to be captured in the track record of managers, to be disclosed under the PPM, and for reporting to performance benchmarking agencies. Purpose: To ensure proper recognition and disclosure of true asset quality, liquidity and fund performance of AIFs and managers. Comment: Considering that the unliquidated investments form very much a part of the portfolio of AIFs managed by the managers and the decision to invest in the same had, at the time of investment, been taken the manager, it is only fair that the same be included in the track record and reports on performance benchmarking. This is in line with the fiduciary duties of the manager at all points of time to the fund and may nudge the managers to go an extra mile and pay due attention to exit strategies at the time of investment.

Standardised approach to valuation of investment portfolio of Alternative Investment Funds (AIFs)

As per SEBI Circular SEBI/HO/AFD/PoD/CIR/2023/97 dated June 21, 2023 a standardized approach for the valuation of Alternative Investment Funds (AIF's) was prescribed. The relevant act i.e. SEBI (Alternate
Investment Funds) Regulations, 2012 (“AIF Regulations”), have been amended and notified on June 15, 2023. The said notification prescribed changes in (1) Manner of valuation of AIF's (Alternate Investment Funds) (2) Responsibility of manager of AIF with regard to valuation of investments of AIF (3) Eligibility criteria for Independent Valuer (4) Reporting of valuation of investments of AIF to performance benchmarking agencies.

So far, the valuation of Alternative Investment Funds (AIFs) was carried out in accordance with Regulation 23 of the Securities and Exchange Board of India Regulations, 2012 (“AIF Regulations”). However, vide circular no. SEBI/HO/AFD/PoD/CIR/2023/97 issued on 21st June 2023, SEBI (Alternative Investment Funds) Regulations, 2012 have been amended.

The Need for Amendment:

Regulation 23 of the SEBI (Alternative Investment Funds) Regulations, 2012; prior to the current amendment, provided the flexibility to these AIFs in adoption of the valuation techniques /methodology in respect of the valuation of investment portfolios and the AIF managers were merely required to provide a description of the valuation procedure/methodology for valuation of the assets.
The modalities relating to valuation of investment portfolio of the AIFs were not disclosed in the Private Placement Memorandum (PPMs) at the time of submission to SEBI and also were not reported to SEBI subsequently.