INSIGHT: Indian Alternate Investment Funds—Application of Anti-Money Laundering Law

To curb practices of money laundering several international initiatives have taken place in the last few decades in the form of UN conventions, the Basel Convention, the Financial Action Task Force (FATF) recommendations, the Vienna Convention, EC directives, and related measures. India has actively contributed to several initiatives and been a signatory to many of these conventions. In 2002 it introduced anti-money laundering laws in lines with global practices and recommendations.

The Prevention of Money Laundering Act, 2002 (PMLA), was brought into force from July 2005. Among other matters it prescribes the manner of confiscation of proceeds and assets related to criminal activities About 30 statutes or types of offenses have been identified with some of the most prominent being drug trafficking, terrorism, smuggling, and corruption. Further, the act prescribes the obligation of financial institutions and intermediaries to verify and maintain records of the identity of all their clients and transactions. It requires the financial institutions to furnish information on such transactions to the Financial Intelligence Unit-India (FIU-IND)

Alternate investment funds (AIFs)—being one of the types of intermediaries regulated by the Securities Exchange Board of India (SEBI)—are required to comply with these laws. AIFs are required to report various transactions in relation to its investors, the key ones being:

• all suspicious transactions (suspected to be connected with proceeds of crime),

• cash transactions and all transactions involving receipts by nonprofit organizations (NPOs) with a value of more than 1 million Indian rupees ($13,232) or the equivalent, and

• all cross-border wire transfers of more than 500,000 Indian rupees ($6,616) or the equivalent.

Since in the AIF industry in India, each investor is mandated to invest a minimum of 10 million Indian rupees ($132,000), making the above mentioned threshold meaningless for the AIF industry.

Similarly, SEBI issues directions from time to time on the transactions to be reported by intermediaries regulated by it and provides an illustrative list of circumstances, which include suspicious transactions such as where the source of the funds is not clear, or not in keeping with client’s apparent standing/business activity; or investors based in high risk jurisdictions.

One of the ambiguities faced by the industry is whether investments made by family offices need to be reported. It’s common for family offices to use trusts as investment vehicles. On the face of it, the definition of NPO covers all trusts. Based on an interpretation, going by the intention of the legislation, and further relying on FATF recommendations, it should be possible to take a position that family offices are not covered within NPOs. Further, what is required to be reported are “receipts by an NPO” and not investments by an NPO. Such receipts by NPOs ordinarily would be required to be reported by the bank that holds the NPO’s bank account and not the AIF.

Another type of transaction is investments from non-resident Indians. The law requires cross-border transactions in foreign currency to be reported. In practice, the funds are first received in a local bank account of the investor, after which the same is received by the AIF. Here again it’s the bank that receives the funds and would be required to report the specified transactions with the FIU-IND. Also, even if the money is directly received by the AIF from overseas, the same would be routed through an authorized dealer (generally the bank that holds the AIF’s bank account) and accordingly, the same should be reported by that authorized dealer. In any case, the AIF will not have all the information needed to be furnished in Form CBWTR, which suggests that it is only the institution that receives remittance in foreign currency and is obligated to report such transactions. The SEBI Master Circular also does not mention such transactions to be reported by the intermediaries.

Like AIF’s, mutual funds are another popular investment vehicle in India, which aim to raise funds from retail investors. The Association of Mutual Funds in India (AMFI) is the industry body that self-regulates mutual funds. AMFI, in consultation with FIU-IND, issues guidelines and criteria for identifying reportable transactions, based on which transactions are monitored and analyzed for further reporting by the mutual fund industry.

As compared to AIFs, which are at a relatively nascent stage in India, the mutual fund industry in India is far more evolved and mature with several large domestic and multinational players with sizeable assets under management. Its industry body, the AMFI, has been recognized as one of the highly respected industry bodies actively engaged in consultations with the regulator. Conceptually and from a PMLA perspective, there is not much difference between a mutual fund and an AIF. Hence, in the authors’ view, it would not be out of place for the AIF industry to draw guidance from AMFI to the extent appropriate and relevant. In fact, the AMFI guidelines also mention portfolio management services (PMSs) and AIFs in case any of its members are also engaged in PMS or AIF business in addition to managing a mutual fund. The guidelines say that an asset management company that has a PMS/AIF division under its fold must ensure that appropriate anti-money laundering measures suggested by AMFI are also applied to those divisions.

Further, AMFI guidelines are based entirely on SEBI’s Master Circular, which is meant for all intermediaries. Hence, there is no reason why those guidelines, with appropriate modifications, should not apply to AIFs given the similarity of business models.

The SEBI Master Circular also provides additional criteria other than those prescribed by AMFI, which could help to identity suspicious transactions such as multiple transactions through various locations, investors in a specific location, multiple attempts at investments with know-your-customer (KYC) failures.

Based on the above, while there are no specified guidelines prescribed by any AIF industry body to classify any particular transaction as a suspicious transaction, reliance can be placed by AIFs on some of the AMFI parameters.

The table below illustrates some of the AMFI parameters with suggestions on how the same could be adopted by the AIF industry to identify and report the transactions.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Sunil Gidwani and Suraj Nangia are partners at Nangia Andersen LLP.