Alternative Investment Funds Regulations in Bangladesh

Alternative Investment Funds (AIFs) have emerged as a pivotal component of the financial ecosystem in Bangladesh, channeling capital into high-growth sectors such as ICT, e-commerce, manufacturing, and energy. The regulatory framework governing AIFs, crafted by the Bangladesh Securities and Exchange Commission (BSEC), is essential for understanding the operational and legal context of these funds. This essay delves into the legislative and regulatory framework, structural intricacies, management requirements, marketing strategies, investment processes, tax implications, and current trends in the AIF sector in Bangladesh, based on the comprehensive guidelines established by the BSEC.

Legislative and Regulatory Framework

The BSEC introduced the Alternative Investment Rules in 2015, setting the foundation for the registration, regulation, and oversight of AIFs, fund managers, and trustees in Bangladesh. These rules encompass various fund types, including private equity, venture capital, impact funds, and other funds as declared by the BSEC. The legislative framework applies exclusively to funds established or constituted within Bangladesh and lacks extra-territorial reach. Despite the absence of specific bilateral or multilateral instruments, the rules are influenced by international best practices, ensuring alignment with global standards.

Types and Structure of Alternative Investment Funds

Types of AIFs

The primary types of AIFs in Bangladesh are:

  1. Private Equity Funds: These funds invest in private companies, often engaging in buyouts.
  2. Venture Capital Funds: These are focused on early-stage companies, particularly in the technology and innovation sectors.
  3. Impact Funds: These funds aim to generate social or environmental impact alongside financial returns.
  4. Other Funds: As declared by the BSEC, these can include any other forms of investment funds deemed necessary.

Structural Requirements

AIFs in Bangladesh are structured as trusts under the Trust Act, 1882, and must be registered under the Registration Act, 1908. Key structural requirements include:

  • Minimum Fund Capital: At least BDT 100 million.
  • Sponsor Subscription: Sponsors must subscribe to at least 10% of the fund capital, with a pre-registration pay-up of 20%.
  • Fund Manager Investment: Minimum 2% of the fund capital, in addition to the sponsor’s 10% if applicable.
  • Unit Holding Limit: Fund managers and their connected persons must not hold more than 25% of the fund’s units.
  • Investment Tenure: Funds must have a specific tenure of five to fifteen years, extendable by up to two years.
  • Investor Limit: No AIF can have more than 200 subscribed investors.
  • Investment Lock-in: All investments are locked in for three years from the date of issuance of the units.

These requirements ensure a robust and regulated structure for AIFs, promoting investor confidence and financial stability.

Management and Advisory Relationships

Fund Manager Requirements

AIFs must have a registered fund manager, which can be a domestic or foreign entity. Foreign entities must establish a subsidiary in Bangladesh with a minimum paid-up capital requirement. Specific criteria for fund managers include:

  • Capital Requirements: BDT 50 million for a fund manager, with higher requirements for foreign subsidiaries (BDT 100 million to 150 million).
  • Regulatory Compliance: Adherence to International Accounting Standards (IAS) and International Financial Reporting Standards (IFRS) as applicable in Bangladesh.
  • Internal Controls: Maintenance of satisfactory internal controls and compliance procedures.
  • Conflict of Interest Disclosure: Fund managers must disclose any material interests in portfolio companies and act responsibly in a fiduciary capacity towards investors.

Restrictions and Delegation

The BSEC prohibits fund managers from delegating their fund management functions to third parties, ensuring that management and investment decisions are retained within the registered entity. This restriction is aimed at maintaining accountability and regulatory oversight.

Marketing and Investment Process

Marketing Regulations

While the BSEC does not specify detailed rules for marketing materials, AIFs are typically marketed through private placements to local and foreign investors. Fund managers leverage their networks to engage high-net-worth individuals and institutional investors, assessing proposals, financial statements, and market conditions to identify viable investment opportunities.

Investment Restrictions

Investment activities are subject to several restrictions:

  • Equity Focus: At least 75% of the fund capital must be invested in non-listed securities of portfolio companies. Pure debt securities and loans are prohibited.
  • Portfolio Limits: No more than 25% of the fund capital can be invested in a single non-listed portfolio company.
  • Listed Securities: Up to 25% of the fund capital may be invested in listed securities, with a cap of 5% per security.
  • Money Market Instruments: A maximum of 10% of the fund capital may be temporarily invested in money market instruments.

These restrictions aim to mitigate risk and ensure that investments align with the defined investment policies.

Taxation and Reporting

Tax Treatment

AIFs and their managers face specific tax regulations:

  • Tax Exemptions: Income earned from recognized AIFs is exempt from taxation, encouraging investment in high-growth sectors.
  • Corporate Tax: Fund management companies are subject to a 35% corporate tax on income derived from fund management activities.
  • Permanent Establishment: AIFs are considered permanent establishments under Bangladeshi tax laws if they have a place of management or an operational presence in Bangladesh.

Reporting Requirements

Fund managers must prepare and disclose comprehensive reports to investors and the BSEC, including:

  • Annual Reports: Financial statements, balance sheets, income statements, and cash-flow statements audited as per Bangladesh Standards of Auditing.
  • Semi-Annual Reports: Unaudited financial statements and fund reports.
  • Material Disclosures: Investments, fees, expenses, and any legal or regulatory inquiries.

These reporting obligations ensure transparency and regulatory compliance, providing investors with crucial information about the fund’s performance and risk management.

Trends and Future Developments

Industry Growth

The AIF sector in Bangladesh is rapidly expanding, driven by investments in high-growth sectors such as ICT and e-commerce. Venture capital funds are particularly prominent due to the thriving startup ecosystem. The government’s prioritization of ICT and energy sectors further stimulates investment.

Regulatory Adjustments

Stakeholders are advocating for regulatory changes, such as the removal of the 2% stamp duty on fund capital, to incentivize the establishment and growth of AIFs. While these efforts have not yet succeeded, they reflect ongoing engagement between the industry and regulators to create a more conducive investment environment.

Challenges and Considerations

Establishment and Management

While establishing an AIF in Bangladesh is relatively straightforward, fund managers must navigate regulatory requirements and maintain robust internal controls. Key challenges include:

  • High Corporate Tax Rate: The 35% corporate tax rate on fund management income is considered high, potentially affecting profitability.
  • Regulatory Compliance: Adhering to stringent reporting and disclosure requirements necessitates meticulous record-keeping and financial management.

Investor Confidence

Building investor confidence is crucial for the success of AIFs. Transparent reporting, robust risk management, and compliance with regulatory standards are essential for attracting and retaining investors.

In conclusion, the regulatory framework for AIFs in Bangladesh, as established by the BSEC, provides a structured and supportive environment for the operation and growth of these funds. While challenges such as high corporate tax rates and regulatory compliance exist, the overall landscape is conducive to investment in high-growth sectors. As the industry matures, ongoing regulatory adjustments and stakeholder engagement will be vital in shaping the future of AIFs in Bangladesh, ensuring they continue to contribute significantly to the country’s economic development.

 

 
 

Amendments to the Alternative Investment Rules in 2020

1. Expansion of Definitions:

  • Eligible Investor and Investor: The definitions of “eligible investor” and “investor” have been broadened to include “foundations” and “approved gratuity funds.” Additionally, the term “provident fund,” which was previously eligible as an investor, now requires the prefix “recognized,” denoting its official status. Similarly, “superannuation fund” must now be prefixed with “approved,” and “gratuity fund” with “approved.” These changes necessitate the certification or accreditation of the aforementioned funds to qualify as eligible investors. This amendment aims to enhance the credibility and regulatory compliance of the funds participating in alternative investments.

2. Private Equity Fund Track Record:

  • Operational Track Record Requirement: The mandatory operational track record for a private equity fund to be eligible has been extended from two years to three years. This amendment ensures that only those private equity funds with a more substantial operational history can participate, thereby potentially increasing the stability and reliability of such investments.

3. Venture Capital Fund Investment Criteria:

  • Investment in Established Companies: The amendment allows venture capital funds to invest in companies that have been operational for three years, replacing the previous requirement of two years. This change is intended to broaden the range of investable opportunities for venture capital funds, allowing them to support more mature companies with established business models.

4. Financial Reporting Standards:

  • Preparation of Financial Statements: The amendments mandate that financial statements must be prepared in accordance with International Financial Reporting Standards (IFRS) as applicable in Bangladesh. Additionally, audited financial statements must comply with International Standards on Auditing (ISA). These requirements aim to enhance the transparency, comparability, and reliability of financial reporting for alternative investment funds.

5. Consent for Fund Disbursement:

  • Trustee Consent for Non-Listed Securities: The fund manager is now required to obtain consent from the trustee prior to disbursing funds to any non-listed securities of portfolio companies. This amendment introduces an additional layer of oversight to ensure that fund disbursements are subject to proper scrutiny and align with the fund’s investment strategy and risk management policies.

6. Valuation of Investments:

  • Frequency of Independent Valuation: The frequency of independent valuations of fund investments has been relaxed from twice a year to a minimum of once a year. This amendment aims to reduce the administrative burden on fund managers while still ensuring that fund valuations are conducted regularly to provide accurate and up-to-date information to investors.

7. Document Sharing with Investors:

  • Electronic Document Sharing: Apart from constitutive documents, financial documents, and other relevant documents must now be shared with eligible investors. The amendment allows these documents to be provided in electronic form, offering added flexibility and convenience compared to the previous requirement of printed hard copies.

8. Performance Fee Restriction:

  • Profit Sharing Limitation: A restriction has been placed to prevent fund managers from sharing the profit from the fund twice as a performance fee. This amendment aims to protect investors from potential overcharging and ensures fair and transparent performance fee arrangements.

9. Fund Manager’s Holding:

  • Increased Holding Limit: The permissible holding by the fund manager in unit funds has been increased from 25% to 30%. This amendment provides fund managers with greater flexibility in managing their stakes in the funds they oversee.

10. Lock-in Period for Investments:

  • Reduced Lock-in Period: The lock-in period for investments in funds has been reduced from three years to two years. This amendment aims to enhance the liquidity and attractiveness of alternative investment funds for potential investors.

11. Disclosure of Connected Persons’ Investments:

  • Annual Report Disclosure: Investments by connected persons of the fund manager in alternative investment funds must now be disclosed in the annual reports. This amendment promotes greater transparency and helps to identify potential conflicts of interest.

12. Fee Reductions:

  • Registration Fee: The registration fee has been halved to 0.05% of the fund corpus. This reduction aims to lower the initial cost of setting up an alternative investment fund.
  • Annual Fee: The annual fee of the fund has been reduced by 20% to 0.04% of the Net Asset Value (NAV) of the fund. This reduction aims to decrease the ongoing operational costs for fund managers and investors.

13. Minimum Subscription:

  • Reduced Minimum Subscription: The minimum subscription amount required from each investor has been lowered from BDT 5,000,000 to BDT 1,000,000. This amendment aims to make alternative investment funds more accessible to a broader range of investors.

14. Investment Diversification Flexibility:

  • Risk Management Policy: The amendments allow for greater flexibility in investment diversification according to the fund’s risk management policy. This change enables fund managers to tailor their investment strategies more effectively to mitigate risks and optimize returns.

15. Joint Investments:

  • Joint Investments in Portfolio Companies: The fund is now permitted to make joint investments in a portfolio company along with another fund. This amendment fosters collaborative investment opportunities and the sharing of risks and returns among multiple funds.

16. Life of the Fund:

  • Shortening the Life of the Fund: A new provision allows the life of the fund to be shortened by a vote of a 2/3 majority, similar to the existing procedure for extending the life of the fund. This amendment provides greater flexibility in managing the duration of the fund in response to changing market conditions and investor preferences.

General Guidance:

  • Specialist Advice: The content of this article is intended to provide a general guide to the subject matter. It is strongly recommended that specialist advice be sought to address specific circumstances and ensure compliance with the amended rules.

These comprehensive amendments to the Alternative Investment Rules in 2020 are designed to enhance the regulatory framework, improve transparency, and provide greater flexibility for both fund managers and investors. They reflect an ongoing commitment to fostering a robust and dynamic alternative investment market in Bangladesh.