AIF Regulatory framework evolves from light-touch to right-hold

Simrat Singh | Finserv@vinodkothari.com

When AIF Regulations were formally introduced in 2012, the regulatory approach was deliberately light. The framework targeted sophisticated investors, allowing flexibility with limited oversight. Over the years, however, AIFs have become significant participants in capital markets. Market practices over the decade exposed regulatory loopholes and arbitrages. For example, some investors who did not individually qualify as QIBs accessed preferential benefits indirectly through AIF structures and investors who were restricted to invest in certain companies started investing through AIF making AIF an investment facade. There were concerns regarding circumvention of FEMA norms as well¹. In the credit space, regulated entities such as banks and NBFCs started channeling funds through AIFs to refinance their stressed borrowers, raising concerns around loan evergreening². These developments prompted regulatory response. RBI first issued two circulars, one in 2023 and the other in 2024. Finally, in 2025 formal directions governing investments by regulated entities in AIFs were also issued³. These Directions introduced exposure caps and provisioning requirements.⁴ 

While the RBI addressed prudential risks arising from regulated entities’ participation in AIFs, SEBI focused on investor protection, governance within the AIF ecosystem and curbing the regulatory arbitrages. First it mandated on-going due diligence by AIF Managers⁵. It then mandated specific due diligence⁶ of investors and investments of AIF to prevent indirect access to regulatory benefits. Fiduciary duties of sponsors and investment managers and reporting obligations were progressively codified through circulars. Managers were expected to maintain transparency vis-a-vis their investment decisions, maintain written policies including ones to deal with conflict of interest with unitholders and submit accurate information to the Trustee. What were once broad, principle-based expectations have evolved into detailed, enforceable rules. Regulatory tightening has been matched by a more assertive enforcement approach. SEBI’s recent settlement order⁷ against an AIF underscores its increasing scrutiny of governance lapses, mismanagement of conflicts and inaccurate reporting. This clearly signals that any compliance gaps will no longer be overlooked and are likely to attract regulatory action. In a separate adjudication order, SEBI imposed penalties on both the Trustee and the Manager for the delayed winding-up of the scheme, underscoring that accountability within an AIF structure extends to all key parties and is not limited to the Manager alone.  

However, SEBI’s approach has not been solely restrictive. Alongside regulatory tightening, it has also sought to preserve commercial flexibility and respond to market needs. Examples include the introduction of the co-investment framework⁸ for AIFs, framework for offering differential rights to select investors and a revamp for angel funds⁹.

Together, these measures are reshaping the regulatory landscape for AIFs and their managers. Investors can no longer rely on AIF structures to indirectly obtain regulatory advantages otherwise unavailable to them. As AIFs have grown in scale and importance, what is emerging is a more transparent, prudentially sound and closely supervised regulatory regime designed to align investor protection and commercial flexibility.

1. See SEBI’s Consultation paper on proposal to enhance trust in the AIF ecosystem ↩︎
2. See our write-up on AIFs being used for regulatory arbitrages here. ↩︎
3.  RBI (Investment In AIF) Directions, 2025 ↩︎
4. See our detailed analysis of the Directions here. ↩︎
5. See our write-up on ongoing due diligence for AIFs here ↩︎
6. See our FAQs on specific due diligence of investors and investments of AIFs here. ↩︎
7. See the complete order here ↩︎
8. See our write-up on co-investments here. ↩︎
9. See our write-up on changes w.r.t Angel Funds here ↩︎