Specialised Investment Fund (SIF) is an investment vehicle designed to pool capital from multiple investors, allowing for investments in specific asset classes or sectors. These funds are tailored to meet the unique investment objectives and risk profiles of their investors, often focusing on areas such as Private Equity (PE), Venture Capital (VC), real estate, infrastructure or other specialised sectors. The SIF Regulations introduced by the Securities Board of Nepal (SEBON) in 2019 laid down the first comprehensive legal framework for these funds.

The SIF Regulations cover PE funds, VC funds, hedge funds and other funds that may be prescribed by SEBON over time. While the introduction of these regulations has created a structured framework for regulating such funds, they still have certain limitations. These include ambiguous tax policies, cumbersome approval processes, and fragmented regulatory oversight which can hinder the growth of PE/VC investments in Nepal.

Implementing targeted regulatory improvements is crucial to unlocking the full potential of SIFs and attracting more investment. Clearer tax policies, streamlined approval procedures and more coordinated regulatory oversight will enhance the appeal of these funds and contribute to the growth and dynamism of the broader investment landscape.

Regulatory Reforms for Competitive Investment Climate

Significant changes to the regulations are necessary to create a more transparent and efficient framework that attracts capital and fosters innovation. Below are some suggestions that, if implemented, could enhance Nepal’s investment landscape, promote transparency and efficiency, attract capital, and spur economic growth, job creation and innovation.

1. Streamlining Foreign Investment in SIF through Blanket Approval:

SEBON is the primary regulatory body overseeing PE/VC activities in Nepal. However, the current regulatory framework remains fragmented, with multiple institutions involved in various aspects of approvals and compliance. This fragmentation often leads to delays, inefficiencies, and confusion for both investors and fund managers. While SEBON is responsible for fund registration and compliance, entities like the Nepal Rastra Bank (NRB) and the Department of Industry (DOI) handle foreign investment approvals, resulting in an uncoordinated and cumbersome process.

One-Window Policy can help streamline the approval process for SIFs. Under this policy, SEBON would serve as the sole authority for all regulatory approvals related to PE/VC investments. This could be achieved by establishing a ‘Single Stop Service Center’ within SEBON premises to manage foreign investments in SIFs, as outlined in the provisions of the Foreign Investment and Technology Transfer Act (FITTA). Since the ‘Single Stop Service Center’ falls under the DOI, they can coordinate to provide blanket approval for foreign investments in SIFs. This would not only expedite fund approvals but also strengthen the overall investment framework, making it more streamlined and investor-friendly.

2. Role of Nepal Rastra Bank (NRB): The NRB plays a crucial role in facilitating foreign investments in SIFs. To enhance this process, NRB should permit foreign investments to flow directly into SIF accounts upon receiving approval from SEBON without requiring additional legal clearances. This would streamline the investment process, reduce transaction costs and create a more investor-friendly financial environment. It will ultimately make foreign investments in SIFs more efficient and attractive.

Moreover, the existing regulations require Banks and Financial Institutions (BFIs) to invest in SIFs using their undistributed reserves, which reduces their core capital — a critical component for maintaining capital adequacy ratios. To encourage greater BFI participation in SIFs, NRB should introduce a provision that allows BFIs to invest in SIFs without affecting their core capital. This change would incentivize BFIs to invest more actively in private equity and venture capital (PE/VC) funds, thereby fostering growth in Nepal’s investment landscape.

3. Provision for SIFs to Borrow from BFIs and Through Debt Instruments: The existing SIF Regulations allow funds to borrow loans from international organisations, multilateral corporate investors or corporate bodies by issuing fund units. However, there is no clear provision regarding whether fund managers can obtain loans from foreign or local BFIs or raise capital through debt instruments. This creates ambiguity around whether funds are restricted to raising credit solely through fund unit issuance or if they can also secure financing through traditional banking channels and debt instruments. This can be addressed by introducing a provision that allows fund managers to borrow from BFIs and raise capital through debt instruments. This would eliminate uncertainty about the ability of fund managers to access various financing options, granting them greater flexibility in securing additional funding. With the ability to borrow from BFIs or issue debt instruments, fund managers could expand their investment capacity, support larger projects and manage liquidity more effectively. Such changes would enhance the overall growth and dynamism of Nepal’s PE/VC sector, allowing funds to better capitalise on investment opportunities and contribute to the development of the country’s financial landscape.

4. Provision-Related to Fund of Funds: A Fund of Funds (FoF) is an investment vehicle where a fund invests in a portfolio of other funds rather than directly in portfolio companies. In simple terms, it pools capital and holds a diversified basket of different funds. In developed economies, FoFs play a crucial role in facilitating secondary buyouts, serving as exit channels for larger investments. They also provide diversification by investing in multiple funds, enabling investors to access PE/VC funds without requiring substantial capital commitments.

Currently, the SIF regulations lack provisions for FoFs. While these guidelines may not be immediately necessary, given that Nepal’s PE/VC sector is still in its early stages and most funds are industry-agnostic, such provisions could become vital as the sector matures. As the PE/VC landscape grows, there will likely be a natural shift toward industry-specific funds driven by sector-specific needs. At that point, clear regulations for FoF structures will be essential for channelling capital into targeted industries, further strengthening Nepal’s investment ecosystem.

Additionally, as part of future regulatory developments, provisions allowing offshore funds to invest directly in SIFs should be considered. This could boost capital inflows into Nepal’s investment funds, enhancing the growth and sustainability of the country’s PE/VC sector.

5. Provision Related to Fund Sponsor: Fund sponsors are entities or individuals who contribute at least 10% of the total fund size and play a vital role in the fundraising phase by providing significant capital as limited partners. Despite their importance, the current SIF Regulations lack specific provisions addressing the role of fund sponsors. This has created uncertainty about whether a fund sponsor can participate in multiple funds managed by different fund managers, as well as whether multiple entities — both individuals and institutions — can act as joint sponsors.

Given their critical role in capital formation, it is essential to introduce clear guidelines allowing fund sponsors to participate in multiple funds without restriction. Additionally, explicit provisions should be introduced to permit joint sponsorship, enabling multiple entities or individuals to collaborate as sponsors. These changes would increase flexibility for sponsors, encourage greater capital flow, and promote diversification within the PE/VC landscape.

6. Changes in Minimum Investment Limit: The SIF Regulations have set a minimum investment limit of Rs 5 million per investor and cap the number of unit holders at 200 for fund registration with SEBON. However, this minimum threshold seems impractical for broader participation. Reducing the minimum investment requirement to Rs 1 million and increasing the number of maximum unit holders could streamline the fundraising process, making it more accessible and enabling funds to reach their targets more quickly. This adjustment would encourage a wider range of investors and enhance the overall efficiency of capital accumulation.

7. Clarity in the Provisions for Taxation: The tax regulations for SIFs in Nepal require better clarification, particularly regarding income generated from PE/VC investments. At present, income from these investments is taxed at the source, but there is no specific guidance on how fund managers should be taxed on the earnings they receive for managing these funds. Further, ambiguities under the SIF Regulations create uncertainty over the tax treatment of PE/VC funds, whereas mutual funds benefit from favourable tax exemptions. Ideally, PE/VC funds should be granted similar tax exemptions to those of mutual funds. Clear and well-defined tax guidelines must be introduced either through the annual budget or through amendments to the Income Tax Act. This would minimise ambiguity, encourage investment and strengthen Nepal’s investment ecosystem by ensuring investors are not burdened with taxes.

8. Provision of DFIs as Prospective Limited Partners: Development Finance Institutions (DFIs) are specialised financial entities established by governments to provide risk capital for development projects, often accepting higher risks than commercial investors. Their involvement not only boosts a fund’s credibility by ensuring it meets key development and sustainability standards but also attracts additional investors. DFIs have been the largest contributors to investment funds in Nepal, investing approximately $105.56 million between 2013 and 2023. Their significance goes beyond financial support, as they also offer valuable technical expertise and emphasise development impact, making them particularly important for Nepal.

Despite their crucial role, DFIs have not yet invested in licensed SIF funds. While the SIF regulations recognize bilateral and multilateral corporate investors as eligible Limited Partners (LPs), they do not explicitly mention DFIs, creating uncertainty about their participation. Given the substantial financial and developmental contributions DFIs can offer, it is essential that the SIF regulations explicitly include DFIs as prospective LPs. This would provide clarity and encourage their involvement, further enhancing capital flow and sustainable development within Nepal's investment landscape.

9. Enhancing Participation from Institutional Investors: Institutional investors such as Citizens Investment Trust, Employee Provident Fund, Social Security Fund, Army Welfare Fund, and others play a crucial role in fortifying Nepal’s PE/VC ecosystem due to their significant capital reserves. Although SIF Regulations have identified these institutions as potential investors, internal regulations and investment policies of these institutions lack provision that allows them to invest in SIF. To address this, there is a need for discussions among organisations, relevant ministries, and regulatory bodies to introduce provisions that would easily enable their participation in SIF.

By establishing clear policies and simplifying the investment process, these institutional investors can be encouraged to invest in PE/VC funds. Their involvement would considerably expand the pool of local capital, facilitating investments in startups, SMEs, and innovative sectors, thereby driving broader economic growth in Nepal.

10. Amendments to Ease the Procedures for Non-Resident Nepali Investments: As Non-Resident Nepalese (NRNs) look to diversify their investment portfolios, they are increasingly drawn to high-growth opportunities in both local and global markets. Nepal, in particular, stands out to many due to its combination of financial potential and the emotional ties NRNs have to their homeland. With the SIF regulations enabling their participation, NRNs have become key prospective limited partners in Nepal's PE/VC funds.

However, despite being recognised as eligible investors under SIF regulations, NRNs are classified as foreign investors, according to the FITTA. This classification subjects them to a cumbersome approval process involving multiple regulatory bodies, including the DOI, the Investment Board of Nepal and NRB. Such bureaucratic hurdles can discourage NRNs from investing in Nepal.

To encourage greater participation of Nepali working abroad in the capital market, SEBON has already introduced the practice of issuing IPOs for them. A similar approach could be adopted for NRNs interested in investing in PE/VC funds, reducing regulatory barriers and streamlining the process. Furthermore, treating NRN investments as domestic investments would not only ease regulatory burdens but also significantly boost investments in PE/VC funds, contributing to the development of Nepal's SIF landscape.

Conclusion

The proposed changes to the SIF Regulations have the potential to significantly enhance the investment landscape, leading to substantial economic benefits. By streamlining approval processes, clarifying tax policies and improving regulatory oversight, these reforms will attract both domestic and foreign capital into the PE/VC sectors. This increased investment will provide startups and small and medium enterprises (SMEs) with greater access to essential funding, allowing them to expand operations and launch new ventures. In turn, this will create more job opportunities, reduce unemployment, and improve livelihoods across the country.

Additionally, the reforms will foster a culture of innovation by making capital more accessible and promoting a more diverse startup ecosystem. By lowering minimum investment thresholds and encouraging participation from non-resident Nepali and institutional investors, the changes will broaden the investor base and mobilise more capital for high-growth opportunities. Ultimately, these reforms will stimulate economic activity, support sustainable development, and position Nepal as a competitive investment destination, contributing to long-term economic resilience and prosperity.

(TEAM Ventures, is an industry-agnostic alternative investment firm with a diverse portfolio spanning the energy, technology, real estate, manufacturing, financial institutions, agri-infrastructure, and electric-vehicles sectors.)

(This opinion article was  originally published in the   November 2024   issues of New Business age Magazine.)