On July 29, 2021, SEBI’s board approved a proposal to introduce a framework allowing regulatory relaxations for a class of well-informed investors with a higher risk appetite. These investors have sufficient financial means to absorb potential losses in investments and are well-informed or well-advised by their investment advisors and lawyers to make sound investment decisions. To be called ‘Accredited Investors’, these investors are, as per the SEBI’s press release, “sophisticated enough to not require extensive regulatory protection”. This came after the regulator issued a consultation paper on the concept on February 24, 2021.
If you are rich, you know what you are doing:
The concept of Accredited Investors has been recognised by many security market regulators around the globe. This is a separate class of investors who are allowed to participate in certain investment products which are not available to other investors and are subjected to lesser regulatory restrictions. The eligibility criteria to become an accredited investor varies between countries. However, this status is usually given to those who have a high net worth. In some jurisdictions, like the European Union, experience and knowledge is also a criterion to be eligible to become an accredited investor. Security market regulators view such investors, as sophisticated and having enough wealth at their disposal to hire the services of professionals for sound investment advice and to fend for themselves in making securities market investments. Being wealthy, they are able to absorb losses and hence can take part in risky investments which are otherwise not safe for other investors.
It seems that the SEBI, taking a cue from other jurisdictions, has finally proposed its own regulatory framework for accredited investors.
Eligibility criteria proposed by SEBI:
SEBI’s proposed eligibility criteria as per its concept paper are as under:
One interesting point to note is that like many securities regulators in other jurisdictions, SEBI has linked eligibility to become an accredited investor only to the person’s wealth and has chosen not to consider the investor’s knowledge of and experience in dealing with complex and risky products. This has been heavily criticised by many. We’ll discuss more on than later.
Relaxations available to Accredited Investors:
The relaxations available to this category of investors has not been finalised yet. However, the concept paper by SEBI has categorised the benefits & relaxations that would be available to this investment category as under:
1. Flexibility in minimum investment:
Under various SEBI regulations, a certain minimum investment amount is prescribed to participate in risky investment vehicles. For example, under SEBI (Alternative Investment Funds) Regulations, 2012, Alternative Investment Funds shall not accept from an investor, an investment value of less than one crore rupees. Such minimum investment requirements are prescribed to prevent individuals with lower risk appetites to invest in these risky investment products. However, even individuals with high net worth may not wish to offload Rs. 1 Crore in a single investment product. These investors might wish to diversify in various such schemes offered by different alternative investment funds. Hence, though the concept of minimum investment limits prevents small investors from investing in risky investments, it is also a hurdle for high net worth investors who wish to diversify into more risky assets.
However, under the new proposed framework for accredited investors, eligible investors would be allowed to participate in an existing investment product at a lower threshold as compared to the minimum amount mandated in the respective Regulations.
2. Flexibility in regulatory requirements:
For investors’ protection, SEBI regulations governing various investment products require certain regulatory conditions with respect to prudential norms, investment conditions, audit and reporting aspects, periodic filings, valuation etc. High net worth investors, as discussed hereinbefore, have enough wealth to take the services of lawyers and investment advisors to help them make sound investment decisions or appoint professionals to take such decisions for them. Such lawyers and professional investment advisors can provide the same level of investor protection to their clients by giving legal and investment advice based on individual investment products and the risk-taking appetite of their respective clients. Hence, most of the regulatory requirements for investors protections have no utility for such investors and it only acts as a compliance burden.
Hence SEBI has proposed a relatively relaxed regulatory framework for existing investment products for participation by accredited investors.
3. New products exclusively for Accredited Investors:
Due to globalisation and technological developments, the demand for tailor-made investment products that meet the specific requirements of specific investor’s risk-return profile and with lesser prudential regulations has increased around the globe. Such products have not been readily available in the Indian securities market up until now due to the SEBI’s heavy regulations to protect investors’ interests. However, many of these products may be suitable for well-informed investors, with a relatively high capacity to take financial risks. Accordingly, SEBI has proposed to allow investment funds to issue new investment products exclusively for accredited investors which would be specifically designed as per the accredited investors’ needs and investment profile. These products will be regulated with minimum prudential norms as they will be offered only to accredited investors. This may lead to the introduction of such innovative investment products and thereby, the development of the securities market.
How will it help the securities market?
Though this new regulatory framework would greatly benefit the investors with a high net worth or high incomes, SEBI has proposed the concept in India for a different reason. The recognition of the accredited investor category would produce some benefits to the Indian securities market as well.
Greater diversification:
As discussed hereinbefore, minimum investments norms would be relaxed for Accredited Investors. This helps Accredited investors diversify their investments in more investment products. Therefore such investors would be able to manage volatility, preserve capital and lead to a more consistent wealth generation. This reduces risks and encourages more investments.
Innovative Financial Products and Services:
Due to regulatory relaxations, financial service firms and investment funds would be able to provide more innovative investment products which otherwise would not have been available due to the risks attached with them. The framework encourages such service providers to offer tailor-made investment products to their clients. This will help the participants to attain their investment goals more efficiently. These products would contribute to the deepening of capital markets, which in turn would foster economic development.
Better capital allocation:
There are many investment opportunities with potentially high rewards for the investor as well as the economy in general which are left unattended due to potentially high risks attached. This new framework would promote capital infusion and channelise resources to more productive resources which would serve greater rewards but are also attached with risks.
Lesser regulatory compliances:
SEBI has hinted towards lesser regulatory requirements with respect to disclosure norms, periodic filings etc. There would be a lesser compliance burden on accredited investors, financial service providers and issuers of securities. Therefore, it is expected that compliance costs would be reduced. However, one would have to wait to comment on the actual compliance burden and costs as there would be new compliance aspects related to verification of accredited investors, certificate by a chartered accountant with respect to eligibility, etc. Issuers of securities and investment products may be required to take reasonable steps to verify the eligibility of their investors or clients. However, one can argue that the compliance costs as a percentage of investment size and returns would reduce substantially. In any case, we would witness the ease of capital formation.
Focus on the vulnerable investors:
Through this framework, SEBI has in effect, classified investors into those who need their attention and those who do not. Accredited investors are, in the eyes of SEBI, investors that do not require its protection. Hence, SEBI can direct all its energies and resources towards small investors who often are the ones who need SEBI’s protection.
Should wealth be the only indicator?
As discussed earlier, in its proposed definition of accredited investors, SEBI has in effect linked an individual person’s wealth to him being ‘well-informed’. This is commonly so in other jurisdictions as well. Hence, many market experts state that the accredited investor category is poorly conceptualised. The Securities Exchange Commission, the securities markets regulator of the USA, has recognised that “higher income and net worth does not necessarily correlate to a higher level of financial sophistication”. Being wealthy and having the ability to sustain losses does not mean one is well-informed and emphasis should also be given by SEBI to the latter. In the European Union, investors are eligible to be ‘Elective Professional Clients’ or ‘Experienced Investors’ (UK and EU equivalent to Accredited investors) if they are engaged in the business of investment management or are professional clients having relevant experience.
The definition should include not just those with wealth but also a combination of knowledge and prior experience in dealing with risky products.
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