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In a consultation paper issued today, SEBI has proposed that it will bar those AIFs from raising fresh commitment or making investment in a new investee company who follow ‘priority distribution (PD) model’ i.e. not distributing income and losses proportionately.
A few AIFs follow ‘priority distribution model’ through which they distribute income disproportionately to a particular set of investors. For instance, if an AIF has two class of investors - type A and type B and it gives more priority to type A then whenever it receives a cash flow, it would distribute the cash flow to type A before distributing the remaining amount to type B.
Sharing the rationale, SEBI said, “It is evident that such a structure with differential distribution has inherent conflict of interest issues and is highly prone to misuse, by benefitting from regulatory arbitrage. The safeguards proposed by the working group do not appear to address the concerns relating to priority distribution model. AIFs with differential distribution waterfall, may serve the interest of only select investors or sponsor/manager and thus, has inherent structural vulnerabilities. Further, AIFs with the model provide significant scope for mis-selling to investors. AIFs with priority distribution model may be misused to mask true asset quality, which may lead to ever-greening of bad/doubtful assets. It may therefore not be prudent to permit AIFs to adopt PD model.”
SEBI has proposed that it will introduce a pro-rata model to distribute cash flow or pass on losses among all investors.
