Sebi recently came out with a proposed regulatory regime for alternative investment funds ( AIF). While the regulator has its heart in the right place, the proposals need to be thought through from the ground up.

What Sebi now seeks to do is create an umbrella regulatory regime for all funds. Sebi's stated objective is three-fold. First, create a regulatory framework which registers different types of funds based on investment objective like private equity, real estate, venture capital, debt, infrastructure, SME, social venture and strategy funds. This would enable targeted benefits for a particular sector.

Second, to get a handle on systemic risk. As some overseas funds may be highly leveraged they may cause system-wide instability.

Third, to improve disclosures, provide for conflict of interest and prohibit fraudulent acts. It is difficult to argue with these goals. Unfortunately, while talking about these, the paper ends up doing something quite different. It seeks to impose investment and other restrictions on these funds, which would hurt the industry without any regulatory benefit.

The most damaging aspect of the proposal is that the paper seeks to create investment silos and imposes restrictions on where each type of fund may invest. This takes away the only free lunch available in the financial markets - of diversification in different types of companies. Thus, a fund which wants exposure in SMEs, early stage companies and listed companies would be prohibited from investing unless they create three different pools.

Read details on Sandeep Parekh's blog

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