Corporate Law Newsletter – Alternative Investment Funds: Financial Year 2024-25 : May 2025
Introduction
The previous financial year witnessed some major changes in the Alternative Investment Fund (“AIF”) industry brought in by the Securities and Exchange Board of India (“SEBI”). SEBI has time and again systematically amended the SEBI Alternative Investment Fund Regulations, 2012 (“AIF Regulations”) to address the needs of the market and maintain a tight regulatory grip over the AIFs. While fund managers grapple to wrap their heads around this string of amendments, here is a roundup of some of the most important amendments and their impact on all the stakeholders that are a part of this ever-evolving AIF ecosystem.
Securities and Exchange Board of India (Alternative Investment Funds) (Fifth Amendment) Regulations, 2024:
On November 18, 2024, the SEBI (Alternative Investment Funds) (Fifth Amendment) Regulations, 2024 introduced key changes to enhance the fairness and transparency of investor rights.
The main provisions of the amendment include:
- Pro-Rata Treatment of Investor Rights and Distributions: The amendment mandates that investor rights, including distributions (i.e., returns on investment), must be pro-rata to the investor’s commitment to the fund, unless specified otherwise by SEBI. This means that returns and rights must be proportional to the amount of capital invested by each investor, ensuring equitable treatment across all investors in a fund. Pari-Passu Rights with Allowances for Differential Rights: The regulation specifies that the rights of investors must be pari-passu (i.e., equal and ranking on the same level). However, it allows for differential rights for select investors in certain cases, provided such rights do not harm the interests of other investors.
- Pari-Passu Rights with Allowances for Differential Rights: The regulation specifies that the rights of investors must be pari-passu (i.e., equal and ranking on the same level). However, it allows for differential rights for select investors in certain cases, provided such rights do not harm the interests of other investors.
For pari-passu rights with allowances for differential rights, SEBI has clarified that such right and eligibility to avail the same shall be transparently disclosed in the Private Placement Memorandum of the AIF. For compliance with this requirement, the Standard Setting Forum for AIFs (SFA) shall, in consultation with SEBI, formulate the implementation standards which will prescribe a positive list of specific differential rights that may be offered by AIFs.
- Exemption for Large-Value Funds for Accredited Investors: The amendment clarifies that the above provisions do not apply to large-value funds targeted at accredited investors, provided that each investor of the scheme specifically provides the waiver to this effect. These investors are typically high-net-worth individuals (HNWIs) or institutional investors who are considered sophisticated and capable of understanding the risks involved in such investments.
Further, the circular clarifies that large value fund for accredited investors, whose Private Placement Memorandums are filed with SEBI for launch of scheme post the date of issuance of this circular, may avail exemption from the requirement of maintaining pari-passu rights among investors, subject to making appropriate disclosure in the Private Placement Memorandum of the scheme; and, obtaining undertaking from accredited investor at the time of on-boarding to the large value fund.
Certification requirement for key investment team of manager of AIF:
Regulation 4(g)(i) of the AIF Regulations introduces a new certification requirement for key personnel in the investment teams of the manager of an AIF, aimed at enhancing professionalism and regulatory compliance. To this effect, SEBI (Certification of Associated Persons in the Securities Markets) Regulations, 2007 has been amended which stipulates that, starting from May 10, 2024, at least one key member of the team must pass the NISM Series-XIX-C: Alternative Investment Fund Managers Certification Examination as a condition for AIF registration and the launch of new schemes. This requirement applies immediately to all new applications, while existing schemes and those pending SEBI approval must comply by May 9, 2025. Trustees and sponsors are responsible for ensuring that the compliance with this certification is reflected in the “Compliance Test Report” as outlined in SEBI’s Master Circular dated May 7, 2024.
The introduction of this mandate raises the competency standards for AIF Managers, ensuring that at least one team member holds recognized qualifications, thereby fostering greater accountability and investor confidence. Further, this requirement can contribute to raising the bar in terms of industry standards. However, fund management and investment decisions are primarily driven by practical expertise, and such certifications may impose unnecessary constraints, especially for senior members with significant industry experience.
Further, the NISM Series-XIX-C certification primarily focuses on regulatory compliance and industry practices. While this is important, it may not comprehensively cover all the competencies required for managing alternative investments, such as deep knowledge in specific asset classes. The certification might not fully address the diverse and complex skill set required by AIFs, potentially limiting the value of the qualification in highly specialized or complex investment strategies.
Relaxation in requirement of intimation of changes in the terms of the Private Placement Memorandum of AIFs through Merchant Banker:
On April 29, 2024, SEBI by way of a circular relaxed the procedural requirements for notifying changes to the Private Placement Memorandum (“PPM”) of AIFs through merchant bankers. This relaxation is aimed to reduce administrative burdens, allowing AIFs to adapt their operational strategies more efficiently in response to market conditions. This relaxation will simplify compliance for AIFs by allowing certain changes to their PPM to be submitted directly to SEBI, bypassing the need for a merchant banker. Changes like fund size, affiliate details, commitment periods, investment team information, and reduced fees, among others, are now covered under this streamlined procedure.
With the removal of the requirement to involve merchant bankers in all changes to the PPM, AIFs can potentially save on the associated costs. Merchant bankers typically charge fees for their services in these regulatory processes.
By reducing their role, AIFs can lower operational and compliance costs, which is especially beneficial for smaller funds or those in the early stages of operation. For investee companies, these changes may lead to expedited funding processes and smoother interactions with cost-efficiency, while fund managers may benefit from reduced procedural delays.
While the relaxation reduces the procedural burden, it also raises the potential for a lack of oversight. Merchant bankers typically perform a gatekeeping role in ensuring that the amendments made to the PPM comply with regulatory requirements and maintain transparency.
To maximize the benefits and mitigate the risks, AIFs will need to adopt robust internal compliance mechanisms and ensure that investor interests remain protected.
Framework for Category I and II Alternative Investment Funds (AIFs) to create encumbrance on their holding of equity of investee companies
On April 26, 2024, SEBI introduced a framework enabling Category I and II AIFs who have not on-boarded any investors prior to 25 April 2024, to create encumbrances on their equity holdings in investee companies operating in any of the infrastructure sub-sectors listed in the Harmonised Master List of Infrastructure issued by the Central Government, subject to defined conditions and comprehensive disclosure requirements.
This framework aims to introduce greater flexibility for Category I and II AIFs by allowing them to create encumbrances on their equity holdings in infrastructure sector investee companies. This proposal is intended to facilitate these companies’ ability to raise debt, which is often essential for funding large-scale projects in the infrastructure domain. This increased financing flexibility could lead to improved liquidity for AIFs, allowing them to optimize their investments and potentially attract more investors.
However, it should be noted that in the case of existing encumbrances which were created prior to April 25, 2024 without making an explicit disclosure in the AIFs PPM but created on the securities of an infrastructure investee company, consent of all investors should be obtained by October 24, 2024, (if not taken already) in which case such encumbrances may be allowed to continue. If the consent of all investors is not obtained by the prescribed timeline, the encumbrances are required to be removed by January 24, 2025. Additionally, if the encumbrances were created on securities of an investee company which is not an infrastructure investee company, such encumbrances need to be removed by October 24, 2024.
From investee companies’ perspective, SEBI’s new rule requires that the duration of encumbrance on AIF equity securities align with the remaining tenure of the AIF’s scheme. However, this conflicts with standard industry practice, where lenders typically require security until the loan is fully repaid. Lenders may not accept such security if it must be released before the loan is paid off, making it difficult for long-term infrastructure projects to secure funding through AIFs, which operate on fixed, close-ended timelines.
Conclusion
Together, these amendments from SEBI show a strong move towards making the AIF industry more transparent, fair, and efficient. While the changes aim to protect investors and improve how funds operate, fund managers will need to adjust their practices to follow the rules while still meeting their investment goals.
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