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Mumbai: The Indian capital market regulator’s plan to club private equity (PE) funds with venture capital, or VC, funds, PIPE or private investment in public equity funds, and others under one regulation could restrict the investment flexibility of PE funds, fund managers said.

On the other hand, the proposed regulation has the potential to develop the domestic fund-raising market, they said.

On Monday, the Securities and Exchange Board of India (Sebi) proposed to regulate PE, VC, PIPE, strategy and social sector funds under an omnibus alternative investment funds regulation.

The objective is to help fledgling firms and eliminate systemic risks for investments of high networth individuals (HNIs) in privately managed funds. The regulator has invited public comments on the paper until 30 August.

According to draft norms, PIPE investments will be restricted to shares of small listed companies that are not in any of the market indices, while PE funds can invest mainly in unlisted companies or companies proposed to be listed.

Currently, PE funds have the flexibility to invest in both listed and unlisted firms.

For infrastructure equity funds, a minimum two-thirds of the investment will be in equity of infrastructure projects while strategy funds, including hedge funds, have to follow the investment strategy that they specify at the time of registration.

Similarly, social venture funds can only target social investors who are willing to accept low returns and the investments will be made primarily in areas such as microfinance, while SME (small and medium enterprise) funds can invest only in companies from that category—both listed and unlisted.

Currently, all PE funds, including global funds such as Kohlberg Kravis Roberts and Co., The Carlyle Group LP and Blackstone Group invest across sectors and strategies to earn maximum returns on a diversified portfolio.

Restricting funds to SMEs or PIPEs will not help in diversifying risks for investors, fund managers said.

Funds diversify the risks for investors by investing across sectors and into different types of investments, said Satish Mandhana, managing partner, IDFC Private Equity Co. Ltd, one of the largest infrastructure funds with $1.3 billion under management.

“Too much intervention on the fund strategy can be a problem. If you get too theoretical in specifying the strategy of the fund, it affects the flexibility to invest," said Gopal Srinivasan, chairman and managing director, TVS Capital Funds Ltd.

“PE contributes to about 0.8% of the GDP (gross domestic product). There are close to 3,000 companies with less than 500 crore market capitalization," said Srinivasan. Putting PE and other institutional buyers on equal footing will help PE contribute to about 2% of GDP.

The total investment by PEs over the last six years is about $50 billion (Rs 2.2 trillion today), according to a June report by global consultancy firm Grant Thornton India. Even assuming that all this is at par and assuming an average stake of 25%, the total market value of PE investee companies would be at least $200 billion.

The market cap of the Bombay Stock Exchange is about $1.4 trillion. So, on a conservative basis, PEs already are about 15% of the market.

So far, a significant portion of funds is raised from foreign investors with only a handful of firms raising money from domestic investors such as banks, HNIs and corporations.

“The proposed norms clearly differentiate between a private equity fund, a real estate fund and an infrastructure fund. This will help create a strong domestic investor culture as investors can now fully understand the nature of the PE market," said Srinivasan of TVS Capital Funds.

A few funds which raised money from domestic HNIs faced defaults from such investors when the capital markets turned volatile. Also HNIs did not fully understand the nature of private equity with the money being locked in for three-four years and the concept of capital calls.

The opportunity to raise money from domestic investors may lead to a boost in private equity activity in India, according to some fund managers.

A move by the Chinese government to open up its domestic market to private equity led to the formation of a number of renminbi (RMB) funds, several of them by foreign companies. For instance, last year The Carlyle Group launched an RMB-denominated $100 million fund with the China-based Fosun Group conglomerate to make high-growth investments.

The Blackstone Group is also raising a $765 million RMB-denominated fund.

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