AIF Second Amendment Regulations, 2021 – Regulated Steps towards Liberalised Investment

-Megha Mittal  (

Amidst the various concerns addressed in the Board Meeting dated 25th March, 2021,[1] the Securities and Exchange of Board of India (‘SEBI’) extensively dealt with several issues identified with respect to Alternative Investment Funds (‘AIFs’), inter-alia a green signal to AIFs for investing in units of other AIFs; ambiguity regarding the scope of the term ‘start-up’; and the need for a code of conduct laying down guiding principles on accountability of AIFs, their managers and personnel, towards the various stakeholders including investors, investee companies and regulators.

Thus, with a view to target the issues in consideration, the Board proposed that the following amendments be introduced in the SEBI (Alternative Investment Funds) Regulation, 2012 (‘AIF Regulations’/ ‘Principal Regulations’)[2]

  • provide a framework for Alternative Investment Funds (AIFs) to invest simultaneously in units of other AIFs and directly in securities of investee companies;
  • provide a definition of ‘start-up’ as provided by Government of India and to clarify the criteria for investment by Angel Funds in start-ups
  • prescribe a Code of Conduct for AIFs, key management personnel of AIFs, trustee, trustee company, directors of the trustee company, designated partners or directors of AIFs, as the case may be, Managers of AIFs and their key management personnel and members of Investment Committees and bring clarity in the responsibilities cast on members of Investment Committees; and
  • remove the negative list from the definition of venture capital undertaking.

 The aforesaid proposals, put to the fore in view of the suggestions and requests received from several stakeholder groups like the domestic AIFs, global investors, and the regulatory bodies, have now been notified vide notification dated 5th May, 2021, via the SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2021[3] (‘Amendment Regulations’). A key takeaway from the Amendment Regulations is the flexibility granted w.r.t. indirect investments by AIFs for investment in units of another AIF, however with some riders and possible gaps, as discussed below.

Below we summarise and discuss the amendments introduced vide the Amendment Regulations, and analyse its impact

Investments in AIFs – A liberal, yet guided approach

The Amendment Regulations reflect the lawmakers’ objective to provide for a balanced investment framework for AIFs. While AIFs are now allowed to invest in units of another AIF, such investment options come with several riders, viz. restriction on layers of investment and the nature of the investee AIF.

Amendment Introduced –

Regulation Subject Matter Principal Regulations Amendment Regulations
15 (1) General Investment Conditions (c) Category I and II Alternative Investment Funds shall invest not more than twenty five percent of the investable funds in one Investee Company














(e) Alternative Investment Fund shall not invest in associates except with the approval of seventy  five  percent  of  investors  by  value  of  their  investment  in  the  Alternative Investment Fund




(c) Category I and II of Alternative Investment Funds shall invest not more than twenty five per cent of the investable funds in an Investee Company directly or through investment in the units of other Alternative Investment Funds


(da) (newly inserted)

Alternative Investment Funds which are authorised under the fund documents to invest in units of Alternative Investment Funds shall not offer their units for subscription to other Alternative Investment Funds;


(e) Alternative Investment Fund shall not invest except with the approval of seventy five percent of investors by value of their investment in the Alternative Investment Fund in –

(a) associates; or

(b) units of Alternative Investment Funds managed or sponsored by its Manager, Sponsor or associates of its Manager or Sponsor;

16 (1) Investment Conditions for Category I AIFs (a)    Category I Alternative Investment Fund shall invest in investee companies or venture capital undertaking or in special purpose vehicles or in limited liability partnerships or in units of other Alternative Investment Funds as specified in these regulations


(a)    Category I Alternative Investment Fund shall invest in investee companies, venture capital undertakings, special purpose vehicles, limited liability partnerships or in units of other Category I Alternative Investment Funds of the same sub category;


Clause (b) omitted

17 Investment Conditions for Category II AIFs (a)    Category  II  Alternative    Investment Funds  shall  invest  primarily  in  unlisted  investee companies  or  in  units  of  other  Alternative  Investment  Funds  as  may  be  specified  in  the placement memorandum;


(a)    Category II Alternative Investment Funds shall invest in investee companies or in the units of Category I or other Category II Alternative Investment Funds as may be disclosed in the placement memorandum; Explanation.– Category II Alternative Investment Fund shall invest primarily in unlisted companies directly or through investment in units of other Alternative Investment Funds


Clause (b) – omitted

18 Investment Conditions for Category III AIFs (a)    Category  III  Alternative    Investment  Funds  may invest  in  securities  of  listed  or  unlisted investee companies or derivatives or complex or structured products (a)    Category III Alternative Investment Funds may invest in securities of listed or unlisted investee companies, derivatives, units of other Alternative Investment Funds or complex or structured products;


 Clause (b) omitted

Remarks –

Pursuant to the aforementioned amendments, AIFs are permitted to simultaneously invest in units of other AIFs and directly in securities of investee companies. However, such investment has been made subject to the following conditions –

  • Quantum – AIFs shall be guided by the maximum diversification limits, 25% of Investible Funds for Category I and Category II AIFs; and 10% of Category III AIFs.
  • Nature of Investee AIF – The Amendment Regulations provide that an AIF cannot invest in another AIF of a higher category. As such, Category I AIFs can only invest in another Category I AIF, that too of the same subclass. On the other hand, Category II AIFs can invest in Category I or II AIFs, and naturally Category III AIFs can invest in any AIF.
  • Layers of Investee AIF – As a result of the Amendment Regulations, an investee AIFs seem to be disallowed from further investing in an AIF – thus restricting levels of investment to one.

While contours with respect to maximum diversification and nature of AIF are necessary to maintain the sanctity of the investors’ money, implications as regards layers of investment may require reconsideration.

To argue that an investee AIF shall not further invest an investor AIFs investment in the units of another AIF will have several loopholes –

First, once an investment is made by an AIF (say, A) in the units of another AIF (say, B), such investment forms part of the investible funds of the latter. All investment and diversification decisions to be taken by the B shall be based on its investible funds – of which the investment by A forms a part. At this stage, the investments so made cannot be earmarked or separately identified from the investible funds of B. Thus, it may so happen that B further invests in an AIF (say, C) which in turn invests in the securities of the ultimate investee company (say, X) and at the same time, A has also directly invested in the securities of D.

The question that arises is that if the combined indirect and direct investment of A in X exceeds 25% of its investible funds, would A be held to be in breach of the AIF Regulations?

Secondly, if the limitation is only made applicable to investment through other AIFs, the same investee company could be routed through any number of vehicles like companies and LLPs. Evidently, a particular “don’t” rather than several “‘dos” leaves open several windows for the stakeholders to meet objectives.

Hence, the bigger question is ‘what is an indirect investment’

In view of the aforesaid gaps, it is important to understand the meaning of an ‘indirect investment’ and how can the investor measure the quantum of investment. It is suggested that RBI’s “substance over form” stance, as adopted for computation of NOF of AIFs[4], could be mutatis-mutandis applied in the instance case too.

Thus, it is imperative to note that unless a direct nexus can be established between the series of investments, or unless the investment is a see through investment, to state that the investor AIF has acted in violation of the AIF Regulations would render the proposed flexibility in investment, infructuous.

Determining the Contours of ‘Start-ups’

The term ‘start-ups’ has been referred to at several occasions in the Principal Regulations – however without having accorded a defined meaning, thus leaving room for interpretation. While Regulation 19 F (1) of the Principal Regulation laid down the identification criteria as turnover not exceeding Rs. 25 crores, promoted or sponsored by a group whose turnover is less than Rs. 300 crores, it was observed that the definition accorded by the Department for Promotion of Industry and Internal Trade (‘DPIIT’) was updated vide notification dated 19th February, 2019.

Thus, to align the definition of the term ‘start-ups’ under the AIF Regulations with the definition provided by DPIIT from time to time, and to avoid recurring amendments in the AIF to ensure such alignment, the Amendment Regulations have defined the term ‘start-ups’

Amendment Introduced –

Regulation Subject Matter Principal Regulations Amendment Regulations
2 (1) w(a) Definition of ‘start-ups’ Newly inserted –


“startup” means a private limited company or a limited liability partnership which fulfills the criteria for startup as specified by the Department of Promotion of Industry and Internal Trade, Ministry of Commerce and Industry, Government of India, vide notification no. G.S.R. 127(E) dated February 19, 2019 or such other policy of the Central Government issued in this regard from time to time

Remarks –

The idea behind defining the term ‘start-ups’ in alignment with the definition provided by DPIIT is essentially to avoid the need for recurring amendments in the AIF Regulations. Further, a clear definition shall now leave no room for divergent interpretations.

Investment by Angel Funds – Dedicated to Start-ups

Chapter III-A of the AIF Regulations lay down provisions with respect to Angel Funds – a Category I AIF, registered with the objective of raising funds from angel investors and invest the same in ventures that encourage entrepreneurship in the country, by financing them at a stage where it would otherwise be difficult for such entities to raise funds from mainstream sources (think banks, other financial institutions etc.)

Thus, Regulation 19F of the AIF Regulations ascribes certain investment conditions for Angel Funds- the most important one being restricted investment in venture capital undertakings and start-ups only.

However, now that the scope of ‘venture capital undertakings’ stands amended (see discussion below) and start-ups have been accorded a definite meaning, Regulation 19F (1) also stands amended to accommodate the related changes.

Amendment Introduced –

Regulation Subject Matter Principal Regulations Amendment Regulations
19F (1) Investment by Angel Funds Angel funds shall invest in venture capital undertakings which ….


(a)    complies    with    the    criteria    regarding    the    age    of    the    venture    capital undertaking/ start-up issued by the Department of Industrial Policy and Promotion under the Ministry of Commerce and Industry, Government of India vide notification no. G.S.R. 180(E) dated February 17, 2016 or such other policy made in this regard which may be in force


(b)    have a turnover of less than twenty five crore rupees

Substituted –

Angel funds shall invest in start-ups which….


Clause (a) and (b) omitted

Remarks –

Given that the scope of VCUs have been widened, dedicating investments by Angel Funds to Start seems like a natural step. Further, the Principal Regulations did not factor the nature of business proposed by the investees. Now, since the definition is derived from the one given by DPIIT, start-ups propagating innovation, development or improvement of products or processes or services, or if it is a scalable business model with a high potential of employment generation or wealth creation shall be focused upon.

Opening Closed Doors for VCUs

The extant definition of ‘Venture Capital Undertakings’ (‘VCU’) lays down a negative list of activities/ industries in which VCUs shall not be engaged – thus, imposing restraints for Venture Capital Funds (‘VCFs’) to invest in NBFCs/ Gold Financing Companies and other negative list companies. The Board deliberated that the origin of such a negative list, which can be traced back to the recommendation in the report of the Committee led by Shri. K.B. Chandrashekhar in 2000, did not provide any rationale for suggesting specific sectors in the negative list.

Hence, considering that a similar negative list of investments is not specified for any other sub category or category of AIFs other than VCFs, the board proposed doing away with the extant negative list.

Amendment Introduced –

Regulation Subject Matter Principal Regulations Amendment Regulations
2 (1) (aa) Definition of Venture Capital Undertaking (a)    Unlisted domestic company at the time of making investment;

(b)    Engaged in the business of providing services/ production/ manufacture, but does not include –

a.      NBFC

b.      Gold financing

c.      Activities not permitted under industrial policy of GoI

d.      Any other activity as may be specified

“venture capital undertaking” means a domestic company which is not listed on a recognised stock exchange at the time of making investments;



Remarks –

A key concern arising due to the negative list was that a major chunk of start-ups were being excluded. The most prominent example could be the fintech start-ups. As of June, 2020, there were over 2100 fintech start-ups in India. Now, given that these most likely fall under the ambit of NBFCs, are devoid of a crucial source of funding, especially curated for start-ups. Thus, removal of the negative list will open closed doors for VCUs which require substantial funding to kick-start their ventures.

Introducing a Code of Conduct – A Bunch of Motherhood Statements

It was observed that unlike other intermediaries in the financial market, AIFs are not governed by any Code of Conduct. Based on industry inputs, media references and review of AIF Regulations, The Board felt the need to prescribe a Code of Conduct for AIFs and their Managers also, thereby laying down guiding principles on their accountability towards the various stakeholders including investors, investee companies and regulators.

As such, keeping in mind the interest of investors and the principle of accountability accompanying authority, and as the same time balancing the same with sufficient flexibility to AIFs, the Amendment Regulations have introduced the Fourth Schedule to the AIF Regulations, thereby laying down a list of dos and don’ts for the AIFs, their managers and sponsors and the Investment Committee (or by such other name as may be known) which is responsible for making investment decisions of AIFs.

Other Amendments –

Contents of Placement Memorandum –

In addition to the comprehensive list of information required to be disclosed by the AIFs in their Placement Memorandum, the Amendment Regulations require the AIFs to also disclose details w.r.t. terms of reference of the committee constituted for approving the decisions of the Alternative Investment Fund

General Obligations & Responsibility & Transparency –

The Amendment Regulations have substituted Regulation 20 of the Principal Regulations to provide inter-alia the following obligations on AIFs, so as to ensure transparency with stakeholders –

  • The management should have detailed policies and procedures, in line with the AIF Regulations, that shall be adopted by the AIFs, its managers, sponsors and key management personnel;
  • The Manager shall be responsible for every decision of the Alternative Investment Fund, including ensuring that the decisions are in compliance with the provisions of these regulations, terms of the placement memorandum, agreements made with investors, other fund documents and applicable laws;
  • The Manager may constitute an Investment Committee (by whatever name called), to approve the decisions of the Altrnative Investment Fund and such constitution shall be subject to such conditions as specified by the Board from time to time;
  • All Alternative Investment Funds shall inform the Board in case of any change in the Sponsor, Manager or designated partners or any other material change from the information provided by the Alternative Investment Fund at the time of application for registration;
  • In case of change in control of the Alternative Investment Fund, Sponsor or Manager, prior approval from the Board shall be taken by the Alternative Investment Fund;
  • The books of accounts of the Alternative Investment Fund shall be audited annually by a qualified auditor


[2] AIF Regulations

[3] Amendment Regulations

[4] Master Direction – Non-Banking Financial Company – Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016 (Para 89)

Our article on the relevant topic can be read here –

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