An AIF raises capital by issuance of units, which are privately placed. Most AIFs follow a commitment–drawdown model, under which investors agree upfront to commit a specified amount of capital (‘committed capital’). The AIF manager then calls this committed capital, either in full or in tranches, as investment opportunities arise (‘drawdown’). This model helps the AIF to minimise the negative carry that would result from raising investments which are yet to be invested.
This fund-raising process is shaped not only by SEBI’s AIF framework but also by the oversight of the respective sectoral regulators of the relevant investors. AIFs are meant strictly for sophisticated investors, and as such, various categories of AIF investors, such as insurance companies, pension funds, banks and NBFCs, etc. are subject to their respective regulations. When they invest in an AIF, they must comply with SEBI’s rules as well as the investment norms prescribed by their own regulators, each seeking to regulate how the capital of the investor is deployed. In fact, SEBI regulations are agnostic as to who the investor is, hence, most of the SEBI regulations relate to the AIF or the manager, with limited provisions dealing with investors. For example, whether and to what extent an insurance company or a pension fund can invest in an AIF is driven by the guidelines issued by the sectoral regulators such as IRDAI or PFRDA.
In this article, we try to bring together, in one place, the key regulatory norms imposed by various regulators; while these are primarily meant for the investor, however, it will be useful for the AIF managers to keep in mind these restraints while expecting or inviting investments from different categories of investors.
Categories of investors and regulatory restrictions on each category
Minimum investment norms: Common across all categories
₹25 crore for investors in Large Value Funds (reduced from ₹ 70 Crore per investor vide SEBI (Alternative Investment Funds) (Third Amendment) Regulations, 2025) [Reg. 2(1)(pa)];
₹1 crore for other investors [Reg 10(c)];
₹25 lakh for employees or directors of the AIF, manager, or sponsor [Reg 10(c)];
No minimum for units issued to employees solely for profit-sharing (and not capital contribution) [Para 4.6 of AIF Master Circular];
For open-ended AIFs, the initial investment must meet the minimum threshold, and partial redemptions must not reduce the holding below this minimum [Para 4.7 of AIF Master Circular].
Individuals
An AIF may raise funds from individual investors, whether resident, non-resident (NRI), or foreign, through private placement, subject to the following conditions (Refer Reg. 10(a) of AIF Regulations r/w Chapter 4 of AIF Master Circular).
Foreign investors: A foreign investor must:
be a resident of a country whose securities market regulator is a signatory to the IOSCO Multilateral MoU (Appendix A) or has a Bilateral MoU with SEBI; or
be a government or government-related investor from a country approved by the Government of India, even if the above condition is not met.
Additionally, neither the investor nor its beneficial owner1:
If a foreign investor ceases to meet these conditions after admission, the AIF manager must stop making further drawdowns from that investor until compliance is restored.
Joint Investments: Joint investments, for the purpose of investment of not less than the minimum investment amount in the AIF, are permitted only between:
an investor and spouse;
an investor and parent; or
an investor and child.
A maximum of two persons may invest jointly. Any other combination of joint investors must individually meet the minimum investment threshold. (Refer Reg. 10(c) of AIF Regulations r/w Chapter 4 of AIF Master Circular)
Terms of Investment: The terms agreed with investors cannot override or go beyond the disclosures in the PPM [Para 4.3 of AIF Master Circular].
The total number of investors is limited to 1000 investors per scheme; also note that an AIF cannot make a public offer. AIF units are commonly offered through distributors; but even the distributors cannot make an open offer (Please refer to our resource on Dos and Don’ts for AIF Distributors and AIF Managers).
Category I AIFs: Infrastructure Funds, SME Funds, Venture Capital Funds, and Social Venture Funds (‘Specified Cat I AIFs’);
Category II AIFs: Only where at least 51% of the corpus is proposed to be invested in infrastructure entities, SMEs, venture capital undertakings, or social venture entities (‘Specified Cat II AIFs’).
Investment in a Fund of Fund (‘FoF’) is allowed only if such FoF does not directly or indirectly invest funds outside India (Refer Section 27E of Insurance Act, 1938). This is to be ensured by inserting a clause in the Fund offer Documents executed by FoF to restrain such FoF investing into AIFs which invest in overseas companies/funds. Further, investment is not allowed in an AIF which in-turn has an exposure to a FoF in which the insurer already invested. Lastly, no investment in an AIF is allowed which undertakes leverage/borrowing other than to meet operational requirements.
Compliance of conditions laid down in (iii) are to be certified by the concurrent auditor of the insurer and filed along with quarterly periodical returns. Notably, insurance companies are prohibited from investing in Cat III AIFs
Prohibited Structures: Insurers shall not invest in AIFs that:
offer variable rights attached to units.
invest funds outside India either directly or indirectly [s. 27E of Insurance Act, 1938];
are sponsored by persons forming part of the insurer’s promoter group;
are managed a manager who is controlled, directly or indirectly, by the insurer or its promoters;
Investment Limits:
For life insurers, combined exposure to AIFs and venture capital funds is capped at 3% of the relevant insurance fund2.
For general insurers, the cap is 5% of total investment assets3.
Exposure to any single AIF cannot exceed the lower of 10% of the AIF’s corpus or 20% of the insurer’s total AIF exposure. For Infrastructure Funds, the 10% limit is enhanced to 20%.
Banks and other Regulated Entities (REs)
Banks and other REs may invest in Category I and Category II AIFs, subject to layered limits:
Bank level: Not more than 10% of the AIF corpus.
Group level: Up to 20% without RBI approval, and up to 30% with prior RBI approval, subject to capital adequacy and profitability conditions.
System level: Aggregate investments by all regulated entities cannot exceed 20% of the AIF corpus.
Banks must ensure that AIF investments do not circumvent banking regulations by creating prohibited indirect exposures. Banks are not permitted to invest in Category III AIFs, except for the minimum sponsor contribution where a bank subsidiary sponsors such a fund. For a more detailed discussion on Banks’ investment in AIFs, refer to our resource here.
NBFCs
An NBFC shall not individually contribute more than 10 percent of the corpus of an AIF Scheme. [See Para 8 of RBI ( NBFC – Undertaking of Financial Services) Directions, 2025]. The system-level investment limit of 20% for all REs shall also apply. Notably, unlike banks, NBFCs can invest in Cat III AIFs.
Pension, Provident and Gratuity Funds
Pursuant to a 15 March 2021 notification, non-government Provident Funds, Superannuation Funds, and Gratuity Funds may invest up to 5% of their investible surplus in Specified Cat I AIFs and Specified Cat II AIFs, classified as “Asset Backed, Trust Structured and Miscellaneous Investments”.
Key conditions include:
Minimum AIF corpus of ₹100 crore;
Maximum exposure of 10% to a single AIF (not applicable to government-sponsored AIFs);
Investments restricted to India-based entities only;
The AIF sponsor and manager must not be part of the fund’s promoter group.
For Government Sector Schemes such as UPS/NPS/NPA Lite/Atal Pension Yojna and Corporate CG schemes, the conditions are the same as above for non-government pension funds.
Mutual Funds
Mutual funds are governed by the SEBI (Mutual Funds) Regulations, 1996. The Seventh Schedule to these regulations sets out the permissible investment universe. Units of AIFs are not included, and accordingly, mutual funds cannot invest in AIF units.
beneficial owner as determined in terms of sub-rule (3) of rule 9 of the Prevention of Money-laundering (Maintenance of Records) Rules, 2005 ↩︎
The relevant insurance fund would refer to the specific fund of a life insurer from which an investment is made, rather than the insurer’s overall balance sheet. This is because Life insurers maintain separate, ring-fenced funds for different lines of business, such as the life fund, pension fund, annuity fund or ULIP fund and investments must be made out of, and limits calculated with reference to, the particular fund whose money is being deployed. ↩︎
Investment assets would refer to the total pool of assets held by a general insurer that are available for investment, across all lines of non-life insurance business. Unlike life insurers, general insurers do not maintain separate, ring-fenced policyholder funds for each product. Instead, premiums collected from various non-life insurance policies are invested as a consolidated portfolio, and regulatory investment limits such as exposure to AIFs are calculated with reference to the insurer’s aggregate investment assets shown on its balance sheet. ↩︎
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-12-24 16:23:482025-12-24 18:17:23A Guide for AIF Managers on Investor Eligibility and Regulatory Restrictions
The RBI has long been stitching up the seams where AIF structures threatened to pull at the fabric of Banking regulation. The latest amendment to the Reserve Bank of India (Commercial Banks – Undertaking of Financial Services) Directions, 2025 is another careful thread in that ongoing work. The provisions apply not only to banks directly but also to exposures routed through their group entities (meaning subsidiary, JV or associate of the bank). Banks (and their group entities) may still participate in AIFs but only within closely drawn boundaries. The message is unambiguous: the AIF route cannot be used to skirt evergreen exposures or manufacture regulatory arbitrage.
Limits on investment in AIF schemes
For Category I and Category II AIFs, limits apply at both the individual bank level and at the group level.
At the bank level, no bank may contribute more than 10% of the corpus of any AIF scheme;
At the bank group level, investments are permitted within a corridor:
Less than 20% of the corpus of Cat I or Cat II AIFs may be invested without prior approval, provided the parent bank continues to meet minimum capital requirements and has reported net profit in each of the preceding two financial years. This means even the AMC along with the bank cannot hold more than 20%;
Between 20% and 30% of the corpus may be invested with prior RBI approval.
A systemic cap overlays this: contributions from all regulated entities – banks, NBFCs, co-operative banks and AIFIs etc. – cannot collectively exceed 20% of any AIF corpus. Similarly investment in the unit capital of REITs and InvITs is capped at 10%, within the overall ceiling of 20% of net worth for equity, convertible instruments and AIF exposures.
A question may arise on whether such limits, as applicable to investments in AIFs, would also be applicable to making investments in FMEs operating in IFSC? Practically, Indian banks are unlikely to invest in FMEs, because such investments would cause the FME to lose its tax benefits. For an FME to qualify as a “specified fund”, all its units must be held by non-residents, except those held by the sponsor. When this condition is met, the income of the fund is exempt under Section 10(4D) and the income received by non-resident investors is exempt under Section 10(23FBC) of the Income Tax Act.
No circumvention of regulations through investments in AIFs
Banks shall ensure that their exposure in an investee company through their investments in AIF schemes does not result in circumvention of any regulations applicable to banks. (see para 38D). This would mean that where a bank is restricted from having any exposure in an investee company (this may include restrictions on account of the end-use of funds, or restrictions in terms of limits to exposures etc), such exposures cannot be made indirectly through making investments in AIF schemes, which, in turn, leads to the bank’s exposures to such investee companies.
Prohibition on Category III AIFs
The clearest prohibition concerns Category III AIFs. Banks are not permitted to invest in their corpus at all. If a subsidiary is a sponsor, it may hold only the minimum contribution required under SEBI’s regulations (which currently is lower of 5% of the corpus or ₹10 Crore as per proviso to Regulation 10(d) of the SEBI AIF Regulations, 2012). Highly traded, leveraged or long-short strategies are thus kept outside the perimeter of bank funding in a deliberate effort to insulate bank balance sheets from hedge-fund-type risk.
Globally, regulators have taken a different, more permissive route. In the United States, banks are not barred from investing in hedge-fund-type vehicles. Instead, the Volcker Rule restricts ownership to de-minimis levels, generally up to 3% of a fund and 3% of Tier 1 capital in aggregate.1
Under Basel’s CRE 60 framework, investments in funds are permitted, however, discipline lies in capital treatment:
If the bank can look-through to underlying exposures, risk weights are based on the underlying assets2;
Where transparency is not available, risk weights can rise to punitive levels, up to 1,250% – making opaque fund exposures extremely capital-intensive.
Recently, IMF in its October 2025 Financial Stability Report has highlighted that banks’ exposures to non-banks, including private-credit and private-equity funds, have grown materially, raising concerns about concentration and potential spill-over risks.
India therefore stands apart. Where other jurisdictions rely on expensive capital and other constraints to manage hedge-fund-type exposures, the RBI has chosen to keep such structures outside the banking perimeter altogether.
Provisioning and Capital Treatment
Capital consequences have also been tightened. Where a bank holds more than 5% of the corpus of an AIF that subsequently invests – other than in equity instruments3 – into a debtor company of the bank, a 100% provision must be created for the bank’s proportionate exposure (See our write-up on the same here). This directly addresses the risk that AIFs could become conduits for evergreening or indirect refinancing of stressed loans.
Overall Perspective
The Amendment Directions extend the guardrails on AIF participation to the bank group, as against the previous approach of regulating only the bank’s exposures. Guardrails are numerical and backed by provisioning and capital consequences. Any breach in the limits require reporting to RBI, with clear reasons and plan for corrective actions. For existing investments, banks are required to provide an action plan by 31st March, 2026 – ensuring the compliances within a maximum of 2 years, viz., 31st March 2028.
RBI’s stance is more conservative than many international regimes, but the regulatory intent is unmistakable: prudential norms are not to be diluted simply because exposure is packaged through an AIF.
CRE 60 offers three routes for capital treatment – look-through, mandate-based and fall-back – chosen according to how much visibility the bank has into the fund’s underlying assets. ↩︎
Equity instruments means equity shares, compulsorily convertible preference shares (CCPS) and compulsorily convertible debentures (CCDs) ↩︎
Private credit is becoming a new force in India’s lending ecosystem. As traditional banks and NBFCs operate under the strict regulations on capital, exposure and asset quality norms, they are often unable, or unwilling to cater to certain borrowers. In addition, for banks in particular, what kind of lending opportunities can be tapped is often a matter of having typecast lending products, policies and procedures. This leaves occasional, however, lucrative gaps in funding needs which are not serviced by regulated lenders. Into these gaps step in Private Credit AIFs (in India), Business Development Companies (BDCs) and Private Collateralized Loan Obligations (CLOs) (in the USA and Australia), these funds can structure deals creatively, customise financing to borrower needs and capture higher-yield opportunities that conventional lenders must pass over. What is emerging is a parallel channel of credit, one that is nimble, agile and focused.
Globally, this shift hasn’t gone unnoticed. Policymakers and institutions like the IMF have flagged the risks tied to private credit markets, especially around opacity, leverage and borrower quality (see below). Yet in India, the momentum continues to build. Tight constraints on banks, the rise of alternative asset managers and the unmet capital needs of businesses beyond the traditional credit universe are all fuelling rapid expansion.
This article examines what private credit is, why it is growing in India, the risks associated with this market and whether their growth creates regulatory arbitrage relative to banks and NBFCs.
What is Private Credit?
As per an IMF paper1, private credit is defined as “non-bank corporate credit provided through bilateral agreements or small “club deals” outside the realm of public securities or commercial banks. This definition excludes bank loans, broadly syndicated loans, and funding provided through publicly traded assets such as corporate bonds.
Simply, private credit is the lending by non-bank and non-NBFCs. The sector predominantly involves alternative asset managers2 who raise capital from institutional investors using closed-end funds and lend directly to predominantly middle-market firms3.
How is it Different From Normal Credit?
Unlike traditional credit, private credit is typically tailored to the specific needs of each borrower. Repayment terms can, for instance, be aligned with the timing of a funding round or disbursements can be structured to match capital expenditure plans. Interest rates may also be designed on a step-up basis, linked to the borrower’s turnover. Many elements that are otherwise rigid under RBI-regulated lending can be flexibly structured in private credit (see table 2 below). This flexibility is especially valuable for start-ups and small businesses, which often require customised financing solutions that traditional lenders may be unable to provide.
Parameter
Private Credit
Traditional Credit
Source of Capita
Private debt funds (Category II AIFs), investors like HNIs, family offices, institutional investors
Banks, NBFCs and mutual funds
Target Borrowers
Companies lacking access to banks; SMEs, mid-market firms, high-growth businesses
Higher-rated, established borrowers.
Deal Structure
Bespoke, customised, structured financing
Standardised loan products
Flexibility
High flexibility in terms, covenants, and structuring
Restricted by regulatory norms and rigid approval processes
Returns
Higher yields (approx. 10–25%)
Lower yields (traditional fixed-income)
Risk Level
Higher risk due to borrower profile and limited diversification
Lower risk due to stronger credit profiles and diversified portfolios
Regulation
Light SEBI AIF regulations; fewer lending restrictions
Heavily regulated by RBI and sector-specific norms
Liquidity
Closed-ended funds; limited exit options
More liquid; established repayment structures; some products have secondary markets
Diversification
Limited number of deals; concentrated portfolios
Broad, diversified loan books
Role in Market
Fills credit gaps not served by traditional lenders
Core credit providers in the financial system
Table 1: Differences between private credit and traditional credit
How Much of it is in India?
Global private credit assets under management have quadrupled over the past decade to US$2.1 trillion in 20234. Compared with the rest of the world, the private credit market in India is very small, with estimated assets under management of $25 billion to $30 billion as of March 31, 2025, representing about 0.6% of India’s GDP and 30-35% of the total investments made by AIFs in India.5
Figure 1: Private credit share (1%) as a part of overall corporate lending. Source: RBI, AMFI
Figure 2: Size of Private Credit Market. Source: RBI
Reasons for Rise in Private Credit?
Private credit is expanding rapidly because it steps in where traditional banks hesitate. It provides capital for last-mile project completion, cost overruns and promoter equity infusion; areas that fall outside the comfort zone of regulated lending. The asset class has also delivered consistently higher risk-adjusted returns, a compelling draw for global and domestic investors, especially through long phases of low interest rates.6
A key advantage lies in its flexibility. Private lenders can tailor covenants7, link returns to cash flows and restructure repayment terms during stress, offering a level of customisation that conventional bank credit cannot match. For investors, this translates into both diversification and access to high-growth segments that remain beyond the scope of mainstream credit markets.
Sector specific regulatory gaps: There is a concern that tighter bank regulation will continue to encourage the migration of credit from banks to private credit lenders8. Certain regulatory restrictions on banks directly push borrowers toward private credit:
Real estate: Banks cannot lend for land acquisition (Para 3.3.1, Master Circular – Housing Finance), leading to real estate becoming a major private-credit segment, accounting for about one-third of all private credit deals.9
Mergers & acquisitions: Banks are not expected to lend to promoters for acquiring shares of other companies (Para 2.3.1.6, Master Circular – Loans and Advances). Consequently, 35% of private credit deals involve M&A financing. However, RBI’s Draft Directions on Acquisition Finance proposes to somewhat ease this restriction.10
Apart from the above, The IBC significantly strengthened creditor rights and recovery prospects, boosting confidence among lenders and supporting the growth of private credit. At the same time, many borrowers, particularly smaller firms, those with weak earnings, high leverage or insufficient collateral, struggle to access bank loans making private credit a natural alternative11. This shift was further accelerated by an extended period of low global interest rates, which pushed investors to seek higher-yielding opportunities and increased capital flows into private credit strategies.
The most common structure for channelising private credit is an AIF – more specifically, a Category II AIF. A ‘Private Credit AIF’ is essentially an AIF whose primary investment strategy is direct debt financing (by investing in debt instruments) to borrowers outside the conventional banking/syndicated loan market. Since AIFs are not subject to the same regulatory framework as traditional lenders (for example, no deposit-taking, no CRR/SLR requirements etc.), they can offer tailor-made structures such as step‐up interest rates, bullet repayments, equity warrants, convertible features, etc.
A private credit fund requires long-term, stable capital, and frequent redemption demands can disrupt lending strategy. A closed-ended Category II AIF structure suits this model well, as it locks in investor capital for the fund’s life and prevents premature withdrawals. Private credit deals are idiosyncratic and difficult for outside parties to value or trade, lenders typically rely on long-term pools of locked-up capital for financing. One advantage AIFs have over mutual funds is that mutual funds are restricted to investing only up to 10% of their debt portfolio in unlisted plain vanilla NCDs.
Compared to private equity or venture capital, where performance depends heavily on market conditions and timing exits, private credit offers returns that are largely predetermined by contract. The trade-off, however, is that like most AIFs, these investments typically come with multi-year lock-ins and fewer exit opportunities, underscoring their inherently illiquid nature. Typically, investors which can commit long term capital are well-suited to invest in such AIFs – such as pension funds and sovereign wealth funds etc.
Rise of Business Development Companies
A Business Development Company (BDC) is a U.S. investment vehicle designed to channel capital to small and mid-sized businesses that lack easy access to traditional bank financing or public capital markets. BDCs were created by the U.S. in 1980, through amendments to the Investment Company Act of 1940(see sections 2(48), 54 and 55), with a clear policy objective: to allow retail investors to participate in private credit and growth capital, an area previously accessible only to institutional investors.
As per a Federal Reserve Paper: BDCs are a way for retail investors to invest money in small and medium-sized private companies and, to a lesser extent, other investments, including public companies. BDCs are structured in different ways. Public BDCs refer to those with shares traded on national securities exchanges, and those whose shares are not traded on national securities exchanges but placed through SEC-registered or private placement offerings are non-publicly traded BDCs. BDCs typically finance middle-market firms—companies with EBITDA between $5 to $100 million, which historically have had limited access to funding from commercial banks and public debt markets. They also provide finance to development-stage companies in sectors such as technology, life science, healthcare information and services and sustainability industries, and private-equity owned or sponsored companies. Structure and regulatory framework: Legally, a BDC is an unregistered closed-end investment company (fund). To qualify as BDC, a company must invest at least 70% of its assets in ‘eligible portfolio companies’ i.e. firms with market values below $250 million and provide ‘significant managerial assistance’ to its portfolio companies [see section 2(48) of the Investment Company Act, 1940]. These companies are often private, thinly traded public firms, or businesses undergoing financial stress. To avoid corporate-level taxation, they must distribute at least 90% of their taxable income to shareholders each year (like REITs and InvITs in India). BDCs are also permitted to use leverage (up to 2x the amount of assets).
BDCs raise capital through IPOs, follow-on equity issuance, corporate bonds or hybrid securities. While many BDCs are publicly traded on stock exchanges (50 in number), offering daily liquidity to investors, some exist as non-traded BDCs with limited liquidity (47 in number) and yet some as private BDCs (50 in number).12
Investment mix: Although BDCs are permitted to invest in both equity and debt, their portfolios are majorly debt-focused. In practice, 60–85% of a typical BDC portfolio is invested in debt instruments, such as senior secured loans, second-lien loans, or mezzanine debt. Equity investments usually comprise 15–30% of assets.13 Because of this allocation, interest income from loans is the primary driver of BDC earnings. This income tends to be steady and predictable, which aligns well with the BDC structure. For example, Ares Capital, one of the largest BDCs, allocates roughly 78–83% of its portfolio to debt (primarily first-lien loans) and about 17% to equity.
How BDCs generate returns: BDCs generate returns through multiple channels:
Interest income from loans to portfolio companies (the dominant source)
Dividends from preferred or common equity holdings
Capital gains from selling equity stakes or converting and exiting convertible securities
Many BDC loans are floating-rate, which provides partial protection in rising interest rate environments. However, most BDC investments are below investment-grade or unrated and equity positions are often in privately held or financially stressed companies, introducing credit and valuation risk.
Comparison with venture capital, private equity AIFs and Mutual Funds: BDCs are often compared with venture capital and private equity funds because all three invest in private, illiquid companies and may provide strategic or managerial support. The key distinction lies in investor access and structure. Venture capital and private equity funds are privately placed vehicles, restricted to institutions and wealthy investors, with long lock-ups and limited transparency. BDCs, by contrast, are designed to be accessible to retail investors and trade on public exchanges.
This distinction becomes especially relevant when comparing BDCs with AIFs in India, particularly private credit AIFs. Economically, BDCs resemble private credit AIFs; both lend to mid-market companies and rely heavily on interest income. The crucial difference lies in retail participation. In India, AIFs exclude retail participation by making the minimum investment amount of Rs. 1 Crore and prohibiting public issuances. In the U.S., BDCs were created to enable retail participation therefore there are no minimum investment norms and public issuances are allowed for BDCs. In this sense, BDCs can be thought of as private credit AIF-like strategies wrapped in a publicly traded structure, placing them between mutual funds (fully liquid public-market vehicles) and AIFs (illiquid private-market vehicles) on the investment spectrum.
From an Indian regulatory perspective, mutual funds offer the closest structural comparison to BDCs, albeit with important distinctions. Indian mutual funds are not permitted to employ leverage as part of their investment strategy and may borrow only to meet temporary liquidity requirements, capped at 20% of net assets (see Regulation 44 of the SEBI Mutual Fund Regulations). In addition, mutual funds face strict asset-side constraints, including a limit of 10% of the debt portfolio in unlisted plain-vanilla non-convertible debentures (see paragraph 12.1.1 of the SEBI Master Circular on Mutual Funds). These restrictions constrain exposure to illiquid private credit, making a BDC-like structure regulatorily infeasible in India under the mutual fund framework.
Global context: No other major market has created a true equivalent of the BDC. While regions such as Europe, Canada, and Australia have listed private credit funds, specialty finance vehicles, or credit income trusts, these structures typically limit or discourage retail participation. Risk considerations: While BDCs may have stable and regular income, they carry elevated risks. Their portfolios consist largely of non-investment-grade debt and equity in small or distressed companies, often with limited public information. Credit losses, economic downturns or excessive leverage can materially impact returns.
Regulatory Concerns with Growth of Private Credit?
IMF in its 2024 Global Financial Stability Report highlighted risks w.r.t rise in private credit since its growth comes with several structural weaknesses that make the market vulnerable, especially in a downturn. Its rapid expansion is happening largely outside traditional regulatory oversight and because the market has not been stress-tested, the true scale of risk remains unclear. Borrowers tend to be smaller and more leveraged and with most loans being floating-rate, repayment stress can escalate quickly when interest rates rise. Although private credit funds’ leverage appears low compared with other lenders, end borrowers tend to be more highly leveraged than those in public markets, increasing the risks to financial stability.14
The increased complexity and the interconnections with leveraged financial entities create more channels through which unexpected losses in private credit could spread to the broader financial system15
Instruments such as PIK interest16 only defer the problem, increasing loss severity if performance deteriorates. Liquidity is another pressure point since private credit funds are inherently illiquid. Risk is further amplified by layers of hidden leverage, at the borrower, SPV, investor and fund level making contagion hard to track. Layers of leverage are created by the AIF lending against equity to a holding entity, which infuses the equity into an operating company, and the operating company borrowing against such equity.
Because loans are private, unrated and rarely traded, valuation is opaque and losses may remain masked until too late. Growing competition also risks weakening underwriting standards and covenant discipline, particularly as larger banks participate in private deals.
Practical challenges add to this vulnerability. Collateral enforcement may not always hold up legally, say due to restrictions on transferability of collateral (say, shares of a private company). Equity-linked security is volatile as well, and during distress, equity tends to lose its value almost completely. In essence, private credit offers flexibility and returns, but its opacity, leverage, illiquidity and weaker borrower profiles create risks that could surface sharply in stress conditions. Private credit certainly warrants closer attention. Nonbank lenders, especially private credit funds, have grown rapidly in recent years, adding to financial stability risks because they are less transparent and not as firmly regulated.
Do private credit AIFs create any regulatory arbitrage?
What you cannot do directly, you cannot do indirectly – the age-old maxim might apply in case a RE which is otherwise barred by RBI for an object, uses the AIF route to achieve that object. Below we examine some of the distinctions in the regulatory oversight:
Function
Private Credit AIFs
RE
Credit & Investment rules
Credit underwriting standards
No regulatory prescription
No such specific rating-linked limits. However, improper underwriting will increase NPAs in the future.
Lending decision
Manager-led
Investment Committee under Reg. 20(7) may decide lending
Manager controls composition of IC;
IC may include internal/external members;
IC responsibilities may be waived if investor commitment ≥₹70 Cr w/ undertaking Primarily i.e. the main thrust should be in: – Unlisted securities; and/or – Listed debt rated ‘A’ or below
Lending decisions guided by Board-approved credit policy
Exposure norms
Max 25% of investible funds in one investee company.
Exposure is limited to 25% of Tier 1 Capital per borrower and 40% per borrower group for NBFC ML;
No such limit for NBFC BL.
Banks can lend maximum upto 15% of their Tier 1 + Tier 2 capital to a single borrower. Large exposure norms may apply in case of banks and Upper Layer NBFCs
End-use restrictions
None prescribed under AIF Regulations, results in high investment flexibility
Banks cannot lend for land acquisition or for funding a M&A deal [refer ‘sector-specific regulatory gaps’ above] NBFCs do not have any such restrictions. They do have internal limits on sensitive sector exposures which includes capital market and commercial real estate [See Para 92 of SBR]
Related party transactions
Need 75% investors consent [reg 15(1)(e)]
Board approval mandatory for loans ≥₹5 Cr to directors/relatives/interested entities;
Disclosure + abstention from decision-making;Loans to senior officers requires Board reporting [See para 93 of SBR]
Capital, Liquidity & Leverage Requirements
Capital requirements
No regulatory prescription as the entire capital of the fund is unit capital
Minimum net owned funds of ₹10 Cr, CRAR 15% for NBFC-ML and above [See para 133.1 of SBR]9% CRAR in case of banks,
Liquidity & ALM
Uninvested funds may be parked in liquid assets (MFs, T-Bills, CP/CDs, deposits etc.) [15(1)(f)]
NBFC asset size more than 100 Cr. have to do LRM [Para 26]
Leverage limits
No leverage permitted at AIF level for investment activities Only operational borrowing allowed
Leverage ratio of BL NBFC cannot be more than 7 No restriction on NBFC ML however, CRAR of 15% makes results into leverage limit of 5.6 times For Banks, in addition to CRAR, there is minimum leverage ratio is 4%
Monitoring, Restructuring and Settlements
Loan monitoring
No regulatory prescription
RBI-defined SMA classification, special monitoring, provisioning & reporting.
Compromise & settlements
No regulatory prescription
Governed by RBI’s Compromise & Settlement Framework
Governance, Oversight & Compliance
Governance & oversight
Operate in interest of investors Timely dissemination of info Effective risk management process and internal controls Have written policies for conflict of interest, AML. Prohibit any unethical means to sell/market/induce investors Annual audit of PPM termsAudit of accounts 15(1)(i) – investments shall be in demat form Valuation of investments every 6 months
A Risk Management Committee is required for all NBFCs. [See para 39 of SBR] AC [94.1], NRC [94], CRO [95] ID and internal guidelines on CG [100] required for NBFC-ML and above
Diversity of borrowers
Private credit AIFs usually have 15-20 borrowers.
Far more diversified as compared to AIFs
Pricing
Freely negotiated which allows for high structuring flexibility
Guided by internal risk model
Table 2: Differences in regulatory oversight between AIFs and Regulated Entities (REs)
The core difference between private credit AIFs and RBI-regulated lenders lies in regulatory intent. SEBI is a disclosure-driven market regulator, it relies on transparency, governance and informed investor choice. RBI is a prudential regulator tasked with protecting systemic stability, and therefore imposes capital buffers, exposure limits and stricter supervision. Private credit AIFs operate within SEBI’s lighter, disclosure-based approach, while banks and NBFCs function under RBI’s risk-averse framework. This does not always create arbitrage, but it does allow credit activity to grow outside the prudential perimeter. As private credit scales, a coordinated SEBI-RBI framework may be necessary to preserve flexibility without compromising financial stability.
It is important to recognise that Category I and Category II AIFs are prohibited from taking long-term leverage. As a result, any loss arising from their lending or investment exposures does not cascade into the wider financial system. Therefore, concerns around applying capital adequacy requirements to these AIF categories are largely unwarranted.
Conclusion
Though still a small fragment of India’s wider corporate lending landscape, private credit AIFs are steadily gaining ground reaching those nooks and crannies of credit demand that banks and NBFCs often cannot, or would not, serve. Their ability to operate beyond the traditional comfort zone of regulated lenders is what makes this segment structurally relevant and increasingly attractive to borrowers and investors alike.
At the same time, rapid expansion brings the potential for regulatory arbitrage. The RBI has already acknowledged this risk, most notably through its actions on evergreening via AIF structures, ultimately resulting in exposure caps of 10% for individual regulated entities and 20% collectively, along with mandatory full provisioning where exposure exceeds 5% in an AIF lending to the same borrower. These measures serve as guardrails to prevent private credit vehicles from functioning as an indirect tool for evergreening of loans.
A middle-market firm is a firm that is typically too small to issue public debt and requires financing amounts too large for a single bank because of its size and risk profile. The size of middle-market firms varies widely. In the United States, they are sometimes defined as businesses with between $100 million and $1 billion in annual revenue. ↩︎
Payment-in-kind (PIK) is noncash compensation, usually by treating accrued interest as an extension of the loan. ↩︎
See our other resources of Alternative Investment Funds here
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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.
See SEBI’s Consultation paper on proposal to enhance trust in the AIF ecosystem ↩︎
See our write-up on AIFs being used for regulatory arbitrages here. ↩︎
See our write-up on changes w.r.t Angel Funds here↩︎
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Within an AIF structure, funds are committed by the investors and the AIF in turn, through its Investment Manager, makes investments in investee entities in line with the fund’s strategy. Situations may arise where an investee company of the AIF may require additional capital, that the Investment Manager may not be willing to provide out of the fund’s corpus possibly due to multiple reasons such as over-exposure, non-alignment with funding strategy, capital constraints etc.
In such cases, the Manager may encourage investors to commit further funds directly into the investee. This gives rise to what is known as ‘co-investment’ –an investment by limited partners (LPs or investors) in a specific investee alongside, but distinct from, the flagship fund. Globally, these are also called ‘Sidecar’ funds or ‘parallel’ funds.1
Benefits of co-investments
Investors benefit from co-investments primarily in terms of cost efficiency, in the following ways:
No or lower management fees and a reduced rate of carried interest.2
Reducing/ removing operational and administrative expenses such as in due diligence process & deal sourcing
Where management and incentive fees are directly charged on co-investments, they are usually capped and lower than when investing directly into the PE Fund.3
Not only are headline rates4 typically lower, but management fees are often charged on invested rather than committed capital, reducing fee drag and mitigating the J-Curve.5
For Managers co-investment offers the following advantages:
Provide access to expanded capital;
Enables it to pursue larger transactions without over extending the main fund
A Preqin study6 found that 80% of LPs reported better performance from equity co-investments than traditional fund structures.
Fig 2: Investor’s perceived benefits of co-investment
Co-investments by AIF investors in the investees of AIF were primarily offered in accordance with the SEBI (Portfolio Managers) Regulations, 2020 (“PM Regulations”). In 2021, PM Regulations were amended to regulate AIF Managers offering co-investments by acting as a portfolio manager of the investors (see need for regulating the co-investment structure below). The AIF Regulations, in turn, required the investment manager to be registered under PM Regulations, for providing co-investment related services.
Keeping in view the rising demand for co-investments, SEBI, based on a recent Consultation Paper issued on 9th May 2025, has amended the AIF Regulations, vide notification dated 9th September, 2025 and issued a circular in September 2025 introducing a dedicated framework for co-investments within the AIF regime itself. Note that the recently introduced framework is in addition to and does not completely replace the co-investment framework through PM as provided in the PM Regulations.
The newly introduced framework refers to co-investments as an affiliate scheme within the main scheme of the fund, in the form of a Co-investment Vehicle Scheme (CIV) and does not require a separate registration by the Investment Manager in the form of Portfolio Manager under PM Regulations.
Interestingly, in May 2025, IFSCA also issued a Circular specifying operational aspects for co-investments by venture capital funds and restricted schemes operating in the IFSC. In this article, we discuss the new framework vis-a-vis the existing PMS route.
Need for regulating co-investments
Conflicts of interest
Especially around the timing of exit. Main fund vs. co-investors may have different preferences.
Voting rights alignment
Misalignment can fragment decision-making.
Risk concentration for investors
Exposure to a single company rather than a diversified portfolio.
Disclosure and transparency obligations for managers
Other fund investors need clarity on why the deal was structured as a co-investment.
Questions may arise on whether the main fund had sufficient capacity to invest.
Risk of concerns about preferential treatment of select investors.
Operational issues:
Warehousing: main fund may initially acquire the investment until co-investment vehicle is ready; requires proper compensation to the fund for interim costs.
Expense allocation: management costs must be fairly shared between the fund and the co-investment vehicle.
Co-investment through PMS Route – the existing framework
Under the PMS Route, the AIF Manager intending to offer co-investment opportunities to its investors shall first register itself as a ‘Co-investment Portfolio Manager’ (see reg. 2(1)(fa) of PM Regulations) post which it can invest the funds of investors subject to the following conditions:
100% of AUM shall be invested in unlisted securities [see reg. 24(4B)];
Only a manager of a Cat I & II AIF is allowed to offer co-investment;
The terms of co-investment in an investee company by a co-investor, shall not be more favourable than the terms of investment of the AIF [see proviso to reg. 22(2)]:
Terms relating to exit of co-investors shall be identical to that of exit of AIF [see proviso to reg. 22(2)];
Early termination/withdrawal of funds by co-investor shall not be allowed. [see reg. 24(2)(a)]
The AIF Manager, registered as a Co-investment Portfolio Manager, is subject to all the compliances as required under the PM Regulations, read with the circulars issued thereunder, except the following:
The minimum investment limit of Rs. 50 Lac per investor in case of PMS will not apply [see reg. 23(2)];
Min. net worth criteria of Rs. 5 Crore shall not apply to such a PM [see reg. 11(e)];
Appointment of a custodian is not required. (see reg. 26)
Roles and responsibilities of the compliance officer can be discharged by the principal officer of the Manager. [see reg. 34(1)]
Particulars
Discretionary
Non-discretionary
Co-investment
No. of clients
1,92,548
6,733
609
AUM (Rs. Crores)
33,05,958
3,18,685
4,674
Table 1: No. of co-investment clients and their total AUM as on 31.07.2025.
As per Table 1, it is evident that co-investment under the PMS Regulations has not taken off yet. One of the major reasons is the additional registration & compliance burden associated with this route.
Co-investment through CIV : the recently approved framework
“Co-investment” means investment made by a Manager or Sponsor or investor of a Category I or II Alternative Investment Fund in unlisted securities of investee companies where such a Category I or Category II Alternative Investment Fund makes investment;”
The framework is restricted to “unlisted securities” only, for the following reasons:
There is a greater information symmetry in case of unlisted securities;
In case of investment in listed securities, it is difficult to establish whether an investor’s decision to invest is driven by the fund manager’s advice or based on the investor’s own independent assessment;
Co-investments are typically undertaken in unlisted entities.
Reg 2(1)(fa) defines co-investment scheme as:
“Co-investment scheme” means a scheme of a Category I or Category II Alternative Investment Fund, which facilitates co-investment to investors of a particular scheme of an Alternative Investment Fund, in unlisted securities of an investee company where the scheme of the Alternative Investment Fund is making investment or has invested;”
The conditions for co-investment through the AIF route is prescribed through the newly inserted Reg 17A to the AIF Regulations read with the Circular dated September 09, 2025. Additionally, the Circular also refers to the implementation standards, if any, formulated by SFA with regard to offering of the co-investment schemes by the AIFs. Since the CIV operates as an affiliate AIF, in order to make it operationally feasible, a CIV has been granted the following exemptions under the AIF Regulations [See reg. 17A(10) of AIF Regulations]:
No minimum corpus of ₹20 Cr.
No continuing sponsor/manager interest (2.5%/₹5 Cr).
Exempt from Placement Memorandum contents, filing modalities, tenure requirement.
Exempt from 25% single-investee company concentration limit
Investment via PMS vs Investment via CIV of an AIF
Post the AIF Amendment, investors have a choice for investing either through the PMS Route or through the CIV route under AIF Regulations. A comparison between the 2 routes is listed below:
Aspects
Investing through CIV
Investing through PMS
Regulatory framework
SEBI (Alternative Investment Funds) Regulations, 2012
SEBI (Portfolio Managers) Regulations, 2020
Limit on investment by each investor
Upto 3 times of investment made by such investor in the investee company through AIF.
Directly in the securities of the investee company.
Co-terminus exit
Timing of exit of CIV = Timing of exit of AIF Scheme from such investee company.
Co-terminus exit
Eligibility of investor
Only Accredited Investors
Any investor
No regulatory bypass
CIV cannot: – Give indirect exposure to such investees where direct exposure is not permitted to the investors; – Create situations needing additional disclosures; – Channel funds where investors are otherwise restricted.
Considered as direct investment by the investor.
Ineligibility of investors
Defaulting, excused, or excluded investors of AIF cannot participate in CIV.
No such exclusion. This seems like a regulatory loophole.
Operational burden
CIV aggregates co-investors’ exposure; hence, only the Scheme appears on the capital table; Unified voting and simplification of compliance requirements for investees as well
Multiple co-investors appear directly on the investee company’s cap table. Closing times may be different, and operationally difficult for investors and investees to exercise voting rights and ensure compliances at each investor’s level.
Scope for co-investment
Managers can extend co-investment services to investors of any AIF managed by them (Sponsor may be same or different)
A Co-investment Portfolio Manager can serve only his own AIF’s investors, and others only if managed by him with the same sponsor
Ring-fencing of funds and investments
Separate bank & demat accounts for each CIV
Bank & demat account of investor
Leverage restrictions
CIV cannot undertake any leverage.
The PM cannot undertake leverage and invest.
Taxation
Tax pass through granted to Cat I & II AIFs make the investors directly liable to tax except on business income of the AIF
Capital gain and DDT payable by investor directly
Filing a shelf PM
Managers are required to file a separate Shelf PM for each CIV Scheme.
No such requirement
Conclusion
Much of the future trajectory of co-investments in India will depend on how both investors and managers weigh the relative merits of the PMS and CIV routes. While the PMS framework comes with higher compliance costs and additional registration requirements, the absence of a maximum cap on investments by the co-investors may still serve as a motivational factor for continued usage of the same. By contrast, the CIV framework seeks to simplify execution and preserve alignment with the parent AIF, although the 3 times’ cap on the co-investor’s share may be a hindrance for investors, thus making the CIV structure less attractive. Recently RBI had also issued Directions for regulated entities investing in AIFs with a view to curb evergreening and excessing investing in AIF structures (see our article on the same). The AIF Manager shall be cognizant of these restrictions in order to ensure there is no bypass through CIV.
Large institutional investors, sovereign funds and pension funds are likely to be the early adopters of CIV structures, given their scale, accredited investor status, and preference for alignment with fund managers. High-net-worth individuals (HNIs) and family offices, on the other hand, may still prefer the PMS route owing to its flexibility and direct exposure. Over time, the regulatory tweaking of these frameworks, if any and the appetite of investors for concentrated exposure will determine how the Indian co-investment landscape unfolds.
In private equity, the headline rate (e.g., 2% management fee, 20% carry) is what’s stated in the PPM, but the effective rate investors actually pay is usually lower. This depends on factors like fees on committed vs. invested capital, negotiated discounts or preferential terms, and lifecycle adjustments such as fee step-downs post-investment period. ↩︎
The J Curve represents the tendency of private equity funds to post negative returns in the initial years and then post increasing returns in later years when the investments mature. The negative returns at the onset of investments may result from investment costs, management fees, an investment portfolio that is yet to mature, and underperforming portfolios that are written off in their early days: Corporate Finance Institute↩︎
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Corporate relationships and hierarchies are prone to misuse and hence, there are regulatory prescriptions to ascertain and address the areas of conflict. This is usually done through identification of control and/or significant influence, if any, existing between the parties. If there is an element of control /significant influence, the parties may be required to follow a host of protocols – including but not limited to being identified as a promoter, to put in place related party controls, to disclose their transactions and even go for consolidation of accounts, etc.
While in simple structures, it is still possible to objectively conclude the existence of control/significant influence (or the absence of it); in certain complex structures, particularly where unincorporated entities are involved, the determination can be quite subjective and dependent on multiple factors. For instance, in the case of pooled investment schemes (called “funds” henceforth) like mutual funds, AIFs, ReITs, InVITs, etc., the entity would often be formed as a trust which would hold the common hotchpot of funds contributed by investors. Besides investors, there would be multiple parties involved, viz., the fund sponsor, fund manager, and the trustee. Mostly, the fund may not be a legal entity[1]; however, it is segregated from the funds of either the manager or trustees. If there is any element of control or even significant influence on the funds, by any of these investors/parties, it would necessitate treatment of such funds in accordance with regulatory protocols as discussed above. Further, at the next level, if there is any element of control by such funds on other entities, then there would be concerns around indirect control of investors/parties on such other entities as well, percolating through the fund. Therefore, whether the fund is being controlled or significantly influenced by any person, becomes a pertinent question.
In this article, we attempt to analyze the same and try to frame some guiding principles for ascertaining circumstances in which a fund would be said to be controlled or significantly influenced.
Meaning of control
Depending on the specific nature and characteristics, pooled investment funds in India are governed by distinct SEBI regulations, such as, SEBI (Alternative Investment Funds) Regulations 2012, SEBI (Infrastructure Investment Trusts) Regulations 2014, SEBI (Mutual Funds) Regulations 1996, etc. These regulations define the terms “control” or “change in control” in the context of either the sponsor or the manager or both, but not in the context of the fund. Hence, one will have to look towards accounting standards – namely IFRS 10 which sets out guidelines for the assessment of control in the hands of a fund manager. In India, Ind AS 110 replicates the guidance provided under IFRS 10. Detailed discussion on the principles discussed under IndAS 110 is as below.
Components of control
Ind AS 110 refers to three cumulative components of control, viz.,
Power over the investee,
Exposure or rights to variable returns from its involvement with the investee, and
The ability to use its power over the investee to affect the amount of the investor’s returns.
As evident, the Standard assumes a relationship of investor and investee. In case of funds, while there would be investors; however, the asset manager too, may be required to hold a certain percentage in the fund as skin-in-the-game, pursuant to applicable regulations. Therefore, in the case of funds, the asset manager is also in the position of an investor, besides being in the position of a manager.
Here, it is significant to note that the “existence of power” or “exposure to returns” individually does not indicate an existence of control, unless there is a link between power and returns, that is, the power can be used to direct the relevant activities, which would affect the returns of the investee.
Component of control
Test for existence
Existence of power over the fund
Ability to direct the relevant activities, i.e., activities that significantly affect the investee’s returns.
Exposure to or rights over variable returns
Potential to vary investor’s returns through its involvement as a result of investee’s performance
Link between power and returns
Ability to use its powers (of directing relevant activities) to affect the investor’s returns from its involvement with the investee, i.e., the investor shall hold decision-making rights as a principal.
Also, note that what matters is “ability”, whether there is actual use of such power or not, becomes irrelevant.
As power arises from rights, the investor must have existing rights that give the investor the current ability to direct the relevant activities [para B14]. Such rights have been briefly discussed in the later part of this write-up.
Power to direct relevant activities of the Fund
In the context of a fund, the relevant activity would be the management of the asset portfolio of the fund. The said function is primarily performed by the fund manager, albeit, the same may be in the capacity of an agent to the unitholders. Hence, Para 18 of Ind AS 110 requires a decision-maker to determine whether it is a principal or an agent for the fund, since a delegated power cannot signify control.
Fund manager – a principal or an agent
IndAS requires that an investor with decision-making rights (called as “decision maker”), when assessing whether it controls the investee, shall determine whether it is a principal or an agent. An investor shall also determine whether another entity with decision-making rights is acting as an agent for the investor [para B58]. The investor shall treat the decision-making rights delegated to its agent as held by the investor directly [para B59].
Thus, in cases where the fund manager is acting as a mere agent of the investor (that is, the fund manager is under the control of the investor), the decision-making rights of the fund manager are treated as that of the investor itself, and control is assessed accordingly. Therefore, to say that an investor has control over the fund, it is important to establish that the investor has control over the fund manager, who in turn, is acting as an agent of the investor. Here, whether the fund manager itself is able to control the fund or not also becomes a pertinent point for determination.
Para B60 of Ind AS 110 specifies the factors that need to be considered in order to determine whether the fund manager in its capacity of a decision maker, is merely an agent to the principal (other investors) or exercises its decision-making rights in the capacity of a principal to the fund.
The primary factor, holding the highest weightage, in making such determination – is the kick-out rights available with other investors. However, where the same does not conclude fund manager as an agent, various other factors require consideration.
Determination of fund manager as a principal v/s agent
Determining ‘control’ of the investor
Various tests are relevant for determining the control of the investor over the Fund. A summary view of the same is given below:
The table below shows a detailed analysis of each relevant test for assessing the existence of control:
Sl. No.
Test of control
Assessment Remarks
Power to direct relevant activities
1.
Nature of rights
The nature of rights shall be substantive, i.e., providing an ability to direct relevant activities and not merely protective. Protective rights apply only to protect an investor from fundamental changes in the funds’ activities or in exceptional circumstances and do not imply power over the fund.
2.
Majority voting rights
An investor holding more than 50% of voting rights in the fund would generally be considered to have power over the fund, unless such voting rights do not signify substantive decision-making rights.
Mention is also made of the SEBI Circular dated 8th October, 2024 that requires conducting due diligence for every scheme of AIFs where an investor, or investors belonging to the same group, contribute(s) 50% or more to the corpus of the scheme.
3.
Ability to influence other investors into collective decision-making
Where a right is required to be exercised by more than one party, whether the investor has the practical ability to influence other rights holders into collective decision-making is relevant in assessment of control of the said investor over the fund.
4.
Contractual arrangements with other investors
Voting rights as well as other decision-making rights may arise out of contractual arrangements giving an investor sufficient rights to have power over the fund.
5.
Size of an investor’s holding relative to size of holding of other parties
Significantly high voting rights held by one investor, and
Small fragmented holdings by other parties, and
Large number of parties required to outvote one investor
An investor holding substantially higher stake, where other investors are holding fragmented holdings, such that a large number of parties are required to outvote the investor, will give the first investor power over the other investors, even in the absence of majority voting rights.
6.
Exercise of voting rights by other investors
Absolute size of one investor’s holding is higher than the relative holdings of other investors, and
Other investors are passive and do not actively participate in decision-making
Where the stake held by an investor is relatively higher from other investors but not significantly higher to indicate existence of power, however, the other investors do not actively participate in the meetings – the same indicates the unilateral ability of the first investor to direct the relevant activities.
Exposure to, or right over variable returns
7.
Dividend and distributable profits proportionate to holdings
This is directly proportional to the holding of an investor in a fund. Where the holdings of an investor does not comprise a sizable portion of the fund, the same does not indicate a significant exposure to variable returns earned by the fund.
8.
Remuneration for servicing the assets and liabilities of the fund
In the context of a fund, the fund manager provides services w.r.t. the management of its assets and liabilities. The remuneration may contain a fixed as well as a variable component, generally, a percentage based fees based on performance of the fund. However, the same does not indicate an existence of control, if the following elements are present:
Remuneration is commensurate with services provided, and
Terms and conditions are on arm’s length as per customary arrangements for similar services
9.
Returns in other forms
In addition, there might be returns available in other forms providing a right over variable returns of the Fund.
Analysis of examples contained in Ind AS 110
Below, we discuss the examples explained under Ind AS 110 in the context of funds:
Illustration
Facts
Analysis
13
Defined parameters for investment decisions within which fund manager has discretion to invest
Fund manager’s stake in Fund – 10%
Market based fee for services – 1% of NAV of Fund
Assumption that fees are commensurate to services provided
No obligation to fund losses
No independent board in the fund
No substantive rights held by other investors
Current ability to direct relevant activities rest with fund manager since no other investor has substantive rights to affect the fund manager’s decision-making authority
Variability of returns pursuant to fees and investment does not create significant exposure to classify fund manager as principal
Fund manager is an agent, so question of holding control does not arise
14
Fund manager has decision-making discretion in the best interest of investors and in accordance with governing documents
Market based fee for services – 1% of NAV of Fund
Profit sharing upon achieving a specified level of profit – 20% of the Fund’s profits
Assumption that fees are commensurate to services provided
Current ability to direct relevant activities rest with fund manager
Variability of returns pursuant to fees and investment does not create significant exposure to classify fund manager as principal
Fund manager is an agent, so question of holding control does not arise
14A
Fund manager has decision-making discretion in the best interest of investors and in accordance with governing documents
Market based fee for services – 1% of NAV of Fund
Profit sharing upon achieving a specified level of profit – 20% of the Fund’s profits
Assumption that fees are commensurate to services provided
Fund manager’s stake in Fund – 2%
No obligation to fund losses
Removal of fund manager – through simple majority vote of investors, but only for breach of contract
Current ability to direct relevant activities rest with fund manager
Variability of returns pursuant to fees and investment does not create significant exposure to classify fund manager as principal
Removal rights with other investors are in the nature of protective rights, hence, not substantive
Fund manager is an agent, so question of holding control does not arise
14B
Fund manager has decision-making discretion in the best interest of investors and in accordance with governing documents
Market based fee for services – 1% of NAV of Fund
Profit sharing upon achieving a specified level of profit – 20% of the Fund’s profits
Assumption that fees are commensurate to services provided
Fund manager’s stake in Fund – 20%
No obligation to fund losses
Removal of fund manager – through simple majority vote of investors, but only for breach of contract
Current ability to direct relevant activities rest with fund manager
Variability of returns pursuant to fees and investment are substantial for the fund manager to consider personal economic interests in making decisions for the Fund
Removal rights with other investors are in the nature of protective rights, hence, not substantive
Decision-making rights are exercised by the fund manager in the capacity of principal. Variability of returns appears significant to conclude an existence of control.
14C
Fund manager has decision-making discretion in the best interest of investors and in accordance with governing documents
Market based fee for services – 1% of NAV of Fund
Profit sharing upon achieving a specified level of profit – 20% of the Fund’s profits
Assumption that fees are commensurate to services provided
Fund manager’s stake in Fund – 20%
No obligation to fund losses Independent board in fund
Appointment of fund manager – annually through the independent board
Current ability to direct relevant activities rest with fund manager
Variability of returns pursuant to fees and investment are substantial for the fund manager to consider personal economic interests in making decisions for the Fund
Removal rights with other investors are substantive, since fund manager’s appointment is subject to annual approval of independent board, and can be terminated without cause
While variability of returns appears significant to indicate control with the fund manager, more weightage is given on substantive removal rights held by other investors. Hence, the fund manager is considered as an agent, and does not control the fund.
15
Investments in fund through both debt and equity instruments
First loss protection to debt investors
Residual returns to equity investors
Assets funded through equity instrument – 10% of the value of the assets purchased
Fund manager decision-making within parameters set out in prospectus
Market based fee for services – 1% of NAV of Fund
Profit sharing upon achieving a specified level of profit – 10% of the Fund’s profits
Assumption that fees are commensurate to services provided
Fund manager’s stake in Fund – 35% of equity
Other investors for remaining equity and debt – large no. of widely dispersed unrelated investors
Removal of fund manager – without cause, by simple majority
Current ability to direct relevant activities rest with fund manager
Variability of returns pursuant to fees and investment, as well as significant exposure to losses on account of equity investments being subordinate to debt investments are substantial for the fund manager to consider personal economic interests in making decisions for the Fund.
Removal rights with other investors are without cause, still, not considered substantive, on account of the large number of investors required to exercise such rights.
Considering the significant level of exposure to variability of returns, the fund manager is considered principal and controls the fund.
16
Sponsor establishes a multi-seller conduit
Establishes terms of conduit Manages conduit for market based fees (commensurate with services provided)
Approves the sellers/ transferors and the assets to be purchased and makes decisions (in best interest of investors)
Entitled to residual return
Provides credit enhancement (upto 5% of all conduit’s assets, after risk absorption by transferors)
Liquidity facilities provided (except against defaulted assets)
Transferors sell high quality medium term assets to the conduit
Manages receivables on market based service fees
Provides first loss protection through over-collateralisation
Conduit
Issues short term debt instruments to unrelated investors by a conduit
Marketed as highly rated medium term asset with minimum exposure to credit risk
Investors
Do not hold substantive decision-making rights
Current ability to direct relevant activities of the conduit
Exposure to variability of returns through right to residual returns of the conduit and provision of credit enhancement and liquidity facilities
Considering the significant level of exposure to variability of returns, the sponsor is considered principal and controls the fund. The obligation to act in the best interests of the investors is not significant.
The “trust” angle
Funds are usually constituted in the form of a trust, where there is an independent trustee. Further, the investment manager is under an obligation to act in a fiduciary capacity towards the investors of AIF, in the best interest of all investors and manage all potential conflicts of interest [Reg 20(1) of AIF Regulations r/w the Fourth Schedule]. In such a scenario, can it be argued that there can be no element of control over a fund, irrespective of who the contributor is?
In SREI Infrastructure Finance Limited vs Shri Ashish Chhawchharia, the NCLAT, in view of the specific facts and circumstances of the case, held the existence of control of the contributor of the AIF over the investee company of the AIF through the AIF. The matter pertained to identification of the appellant as a related party of the corporate debtor in the context of IBC. The surrounding facts and circumstances are briefly put forth as under:
Therefore, in a given set of facts and circumstances, it might be possible to contend that the fund is being controlled by an investor/group of investors.
Conclusion
In questions involving conflict of interest, control, and relationships, Courts have often adopted purposive interpretation in such cases rather than literal interpretation. As held in Phoenix Arc Private Limited v. Spade Financial Services Limited, AIRONLINE 2021 SC 36, albeit in the context of section 21(2) of IBC would still be relevant. Referring to an authoritative commentary by Justice G.P. Singh which states that the terms may not be interpreted in their literal context, if the same leads to absurdity of law, the Supreme Court held: “The true test for determining whether the exclusion in the first proviso to Section 21(2) applies must be formulated in a manner which would advance the object and purpose of the statute and not lead to its provisions being defeated by disingenuous strategies.” Therefore, whether the fund is being controlled by any person/entity is to be seen in the light of all facts and circumstances, and there can be no straight-jacket formula to arrive at a conclusion.
Other resources on AIFs:
[1] For example, it may be a trust. However, it is possible to envisage funds held in LLP or company format, in which case the fund becomes a separate entity. This article does not envisage a fund formed as a body corporate.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Team Corplawhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngTeam Corplaw2025-09-03 01:03:392025-09-04 17:16:09Decoding “Control” in Pooled Investment Funds: Manager, Investors, or no one?
The RBI’s regulatory approach to investments by Regulated Entities (REs) in Alternate Investment Funds (AIFs) has undergone a remarkable transformation over the past two years. Initially, the RBI responded to the risks of “evergreening”, where banks and NBFCs could mask bad loans by routing fresh funds to existing debtor companies via AIF structures, by issuing stringent circulars in December 20231 and March 20242 (collectively known as ‘Previous Circulars’). The December 2023 circular imposed a blanket ban on RE investments in AIFs that had downstream exposures to debtor companies, while the March 2024 clarification excluded pure equity investments (not hybrid ones) from this restriction. This stance aimed to strengthen asset quality but quickly highlighted significant operational and market challenges for institutional investors and the AIF ecosystem. Many leading banks took significant provisioning losses, as the Circulars required lenders to dispose off the AIF investments; clearly, there was no such secondary market.
In response to the feedback from the financial sector, as well as evolving oversight by other regulators like SEBI, the RBI undertook a comprehensive review of its framework and issued Draft Directions- Investment by Regulated Entities in Alternate Investment Funds (‘Draft Directions’) on May 19, 20253. The Draft Directions have now been finalised as Reserve Bank of India (Investment in AIF) Directions, 2025 (‘Final Directions’) on 29th May, 2025. The Final Directions shift away from outright prohibitions and instead introduce a carefully balanced regime of prudential limits, targeted provisioning requirements, and enhanced governance standards.
Comparison at a Glance
A compressed comparison between Previous Circulars and Final Directions is as follows –
Particulars
Previous Circulars
Final Directions
Intent/Implication
Blanket Ban
Blanket ban on RE investments in AIFs lending to debtor companies (except equity)
No outright ban; investments allowed with limits, provisioning, and other prudential controls
Move from a complete prohibition to a limit-based regime. Max. Exposures as defined (see below) taken as prudential limits
Definition of debtor company
Only equity shares excluded for the purpose of reckoning “investment” exposure of RE in the debtor company
Therefore, if RE has made investments in convertible equity, it will be considered as an investment exposure in the counterparty – thereby, the directions become inapplicable in all such cases.
Individual Investment Limit in any AIF scheme
Not applicable (ban in place)
Max 10% of AIF corpus by a single RE, subject to a max. of 5% in case of an AIF, which has downstream investments in a debtor company of RE.
Controls individual exposure risk. Lower threshold in cases where AIF has downstream investments.
Collective Investment Limit by all REs in any AIF scheme
Would require monitoring at the scheme level itself.
Downstream investments by AIF in the nature of equity or convertible equity
Equity shares were excluded, but hybrid instruments were not.
All equity instruments
Exclusions from downstream investments widened to include convertible equity as well. Therefore, if the scheme has invested in any equity instruments of the debtor company, the Circular does not hit the RE.
Provisioning
100% provisioning to the extent of investment by the RE in the AIF scheme which is further invested by the AIF in the debtor company, and not on the entire investment of the RE in the AIF scheme or 30-day liquidation, if breach
If >5% in AIF with exposure to debtor, 100% provision on look-through exposure, capped at RE’s direct exposure5 (see illustrations below)
No impact vis-a-vis Previous Circulars. For provisioning requirements, see illustrations later.
Subordinated Units/Capital
Equal Tier I/II deduction for subordinated units with a priority distribution model
Entire investment deducted proportionately from Tier 1 and Tier 2 capital proportionately
Adjustments from Tier I and II, now to be done proportionately, instead of equally.
Investment Policy
Not emphasized
Mandatory board-approved6 investment policy for AIF investments
One of the actionables on the part of REs – their investment policies should now have suitable provisions around investments in AIFs keeping in view provisions of these Directions
Exemptions
No specific exemption. However, Investments by REs in AIFs through intermediaries such as fund of funds or mutual funds were excluded from the scope of circulars.
Prior RBI-approved investments exempt; Government notified AIFs may be exempt
Provides operational flexibility and recognizes pre-approved or strategic investments.No specific mention of investments through MFs/FoFs – however, given the nature of these funds, we are of the view that such exclusion would continue.
Transition/Legacy Treatment
Not applicable
Legacy investments may choose to follow old or new rules
See discussion later.
Key Takeaways:
Detailed analysis on certain aspects of the Final Directions is as follows:
Prudential Limits
Under the Previous Circulars, any downstream exposure by an AIF to a regulated entity’s debtor company, regardless of size, triggered a blanket prohibition on RE investments. The Final Directions replace this blanket ban with prudential limits:
10% Individual Limit: No single RE can invest more than 10% of any AIF scheme’s corpus.
20% Collective Limit: All REs combined cannot exceed 20% of any AIF scheme’s corpus; and
5% Specific Limit: Special provisioning requirements apply when an RE’s investment exceeds 5% of an AIF’s corpus, which has made downstream investments in a debtor company.
Therefore, if an AIF has existing investments in a debtor company (which has loan/investment exposures from an RE), the RE cannot invest more than 5% in the scheme. But what happens in a scenario where RE already has a 10% exposure in an AIF and the AIF does a downstream investment (in forms other than equity instruments) in a debtor company? Practically speaking, AIF cannot ask every time it invests in a company whether a particular RE has exposure to that company or not. In such a case, as a consequence of such downstream investment, RE may either have to liquidate its investments, or make provisioning in accordance with the Final Directions. Hence, in practice, given the complexities involved, it appears that REs will have to conservatively keep AIF stakes at or below 5% to avoid the consequences as above.
Now, consider a scenario – where the investee AIF invests in a company (which is not a debtor company of RE), which in turn, invests in the debtor company. Will the restrictions still apply? In our view, it is a well-established principle that substance prevails over form. If a clear nexus could be established between two transactions – first being investment by AIF in the intermediate company, and second being routing of funds from intermediate company to debtor company, it would clearly tantamount to circumventing the provisions. Hence, the provisioning norms would still kick-in.
Provisioning Requirements
Coming to the provisioning part, the Final Directions require REs to make 100 per cent provision to the extent of its proportionate investment in the debtor company through the AIF Scheme, subject to a maximum of its direct loan and/ or investment exposure to the debtor company, if the REs exposure to an AIF exceeds 5% and that AIF has exposure to its debtor company. The requirement is quite obvious – RE cannot be required to create provisioning in its books more than the exposure on the debtor company as it stands in the RE’s books.
The provisioning requirements can be understood with the help of the following illustrations:
Scenario
Illustration
Extent of provisioning required
Existing investment of RE in AIF Scheme (direct loan and/or investment exposure exists as on date or in the past 12 months)
For example, an RE has a loan exposure of 10 cr on a debtor company and the RE makes an investment of 60 cr in an AIF (which has a corpus of 800 cr), the RE’s share in the corpus of the AIF turns out to be 7.5%. The AIF further invested 200 cr in the debtor company of the RE.
The proportionate share of the RE in the investment of AIF in the debtor company comes out to be 15 cr (7.5% of 200 cr). However, the RE’s loan exposure is 10 crores only. Therefore, provisioning is required to the extent of Rs. 10 crores.
Existing investment of RE in AIF Scheme (direct loan and/or investment exposure does not exist as on date or in the past 12 months)
Facts being same as above, in such a scenario, the provisioning requirement shall be minimum of the following two:-15 cr(full provisioning of the proportionate exposure); or-0 (full provisioning subject to the REs direct loan exposure in the debtor company)
Therefore, if direct exposure=0, then the minimum=0 and hence no requirement to create provision.
Some possible measures which REs can adopt to ensure compliance are as follows:
Maintain an up-to-date, board-approved AIF investment policy aligned with both RBI and SEBI rules;
Implement robust internal systems for real-time tracking of all AIF investments and debtor exposures (including the 12-month history);
Require regular, detailed portfolio disclosures from AIF managers;
appropriate monitoring and automated alerts for nearing the 5%/10%/20% thresholds; and
Establish suitable escalation procedures for potential breaches or ambiguities.
Further, it shall be noted that the intent is NOT to bar REs from ever investing more than 5% in AIFs. The cap is soft, provisioning is only required if there is a debtor company overlap. But the practical effect is, unless AIFs develop robust real-time reporting/disclosure and REs set up systems to track (and predict) debtor overlap, 5% becomes a limit for specifically the large-scale REs for practical purposes.
Investment Policy
The Final Directions call for framing and implementing an investment policy (amending if already exists) which shall have suitable provisions governing its investments in an AIF Scheme, compliant with extant law and regulations. Para 5 of the Final Directions does not mandate board approval of that policy, however, Para 29 of the RBI’s Master Directions on Scale Based Regulations stipulates that any investment policy must be formally approved by the Board. In light of this broader governance requirement, it is our view that an RE’s AIF investment policy should similarly receive Board approval. Below is a tentative list of key elements to be included in the investment policy:
Limits: 10% individual, 20% collective, with 5% threshold alerts;
Provision for real-time 12-month debtor-exposure monitoring and pre-investment checks;
Clear provisioning methodology: 100% look-through at >5%, capped by direct exposure; proportional Tier-1/Tier-2 deduction for subordinated units; and
Approval procedures for making/continuing with AIF investments; decision-making process
Applicability of the provisions of these Directions on investments made pursuant to commitments existing on or before the effective date of these Directions.
Subordinated Units Treatment
Under the Final Directions, investments by REs in the subordinated units7 of any AIF scheme must now be fully deducted from their capital funds, proportionately from Tier I and Tier II as against equal deduction under the Previous Circulars. While the March 2024 Circular clarified that reference to investment in subordinated units of AIF Scheme includes all forms of subordinated exposures, including investment in the nature of sponsor units; the same has not been clarified under the Final Directions. However, the scope remains the same in our view.
What happens to positions that already exist when the Final Directions arrive?
As regards effective date, Final Directions shall come into effect from January 1, 2026 or any such earlier date as may be decided as per their internal policy by the REs.
Although, under the Final Directions, the Previous Circulars are formally repealed, the Final Directions has prescribed the following transition mechanism:
Time of making Investments by RE in AIF
Permissible treatment under Final Directions
New commitments (post-effective date)
Must comply with the new directions; no grandfathering or mixed approaches allowed
Existing Investments
Where past commitments fully honoured: Continue under old circulars
Partially drawn commitments: One-time choice between old and new regimes
Closing Remarks
The RBI’s evolution from blanket prohibitions to calibrated risk-based oversight in AIF investments represents a mature regulatory approach that balances systemic stability with market development, and provides for enhanced governance standards while maintaining robust safeguards against evergreening and regulatory arbitrage.
Of course, there would be certain unavoidable side-effects, e.g. significant operational and compliance burdens on REs, requiring sophisticated real-time monitoring systems, comprehensive debtor exposure tracking, board-approved investment policies, and enhanced coordination with AIF managers. Hence, there can be some challenges to practical implementation. Further, the success of this recalibrated regime will largely depend on the operational readiness of both REs and AIFs to develop transparent monitoring systems and proactive compliance frameworks.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-07-31 17:45:492025-08-05 11:10:55Round-Tripping Reined: RBI Rolls Out Relaxed Rules for Investments in AIFs
Alternative Investment Funds (AIFs) are private investment vehicles registered with and regulated by SEBI. Private investment vehicles, as is understood, are investment vehicles that pool investments from investors on a private basis, and make investments in investee entities based on the investment objectives disclosed to the investors. The returns from such investments, net of the expenses incurred by the vehicle, is distributed back to the investors. A typical AIF structure would look like:
The general obligations of AIFs are provided in the SEBI (Alternative Investment Funds) Regulations, 2012 read with the circulars issued from time to time. In addition to that, the Standard Setting Forum for AIFs (SFA) formulates implementation standards for various compliance requirements, as required by SEBI from time to time.
As may be understood, the AIF takes funds from its investors and makes investments in the investees. As between the sponsor/ manager of the Fund and the investors, there is a fiduciary relationship – since the investment decisions taken by the fund manager is on behalf of the investors, and in accordance with the investment objectives disclosed to the investors. Investor protection and transparency and proper due diligence of the investees become crucial in the context of an AIF. As compared to a traditional company, the AIFs are intermediaries between the investors and investees. This article discusses the various compliance requirements as applicable to AIFs.
Governance structure of AIFs
Governing body of AIF: Depending on the legal form of the AIF, the governing body of the AIF may compose of trustee (in case of a trust), directors (in case of a company) or designated partners (in case of an LLP).
Manager: The primary responsibility of ensuring compliance with the applicable provisions by an AIF is on the manager of the AIF. Similarly, ensuring compliance with the internal policies and procedures of an AIF is also the responsibility of the manager. The manager is appointed by an AIF, and the Sponsor may also be the manager of the Fund.
Investment Committee: Constituted by the manager, the Investment Committee approves the decisions of the AIF and is responsible for ensuring that such decisions are in compliance with the policies and procedures laid down by the AIF. The Investment Committee may be composed of internal members (employees, directors or partners of the Manager) as well as external investors (with the approval of the investors in the AIF/ Scheme). The external members may include ex-officio members who represent the sponsor, sponsor group, manager group or investors, in their official capacity. Pending clarification from RBI, currently non-resident Indian citizens are not permitted to act as an external member in the Investment Committee [Reg 20(7) of AIF Regulations read with Chapter 14 of AIF Master Circular].
The responsibilities of the Investment Committee may be waived by the investors (other than the Manager, Sponsor, and employees/ directors of Manager and AIF), if they have a commitment of at least Rs. 70 crores (USD 10 billion or other equivalent currency), by providing an undertaking to such effect, in the format as provided under Annexure 11 of the AIF Master Circular, including a confirmation that they have the independent ability and mechanism to carry out due diligence of the investments.
Key Management Personnel: Key Management Personnel (KMP) of the Manager has been defined to mean:
members of key investment team of the Manager, as disclosed in the PPM of the fund;
employees who are involved in decision making on behalf of the AIF, including but not limited to, members of senior management team at the level of Managing Director, Chief Executive Officer, Chief Investment Officer, Whole Time Directors, or such equivalent role or position;
any other person whom the AIF (through the Trustee, Board of Directors or Designated Partners, as the case may be) or Manager may declare as key management personnel. [Para 13.1.2. of the AIF Master Circular]
The responsibilities of the Manager are complied through the Key Management Personnel of such Manager.
Compliance Officer: The Compliance Officer is appointed by the Manager, and is responsible for monitoring of compliance with the applicable laws and requirements as applicable to the AIF. Compliance Officer, shall be an employee or director of the Manager, other than Chief Executive Officer of the Manager or such equivalent role or position depending on the legal structure of Manager [Para 13.1.1. of the AIF Master Circular].
The Compliance Officer is responsible to report any non-compliance observed by him within 7 days from the date of observing such non-compliance.
Custodian: The Sponsor/ Manager of the AIF is required to appoint a custodian, registered with SEBI, for safekeeping of the securities of the AIF. An associate[1] of the Sponsor/ Manager may also act as a custodian, subject to compliance with certain conditions[2]. The custodian provides periodic reports to SEBI with respect to the investments of AIFs that are under custody with the custodian in accordance with the standards formulated by SFA.
The various roles and responsibilities at the different levels of the governance structure is discussed below.
Code of Conduct for AIFs [Reg 20(1) of AIF Regulations]
The Code of Conduct, as prescribed under the AIF Regulations, puts forth various requirements applicable to the AIFs and other relevant entities. The Code of Conduct is applicable to various responsibility centers charged with the governance requirements in an AIF. The requirements are given in the Fourth Schedule to the AIF Regulations read with Para 13.3. of the AIF Master Circular.
The applicability to various stakeholders along with the requirements are given in the table below:
Person covered by the CoC
Requirements to be adhered to under the CoC
AIF
Undertake business activities and investments in accordance with the investment objectives in the placement memorandum and other fund documents [to be ensured by the Manager]
Be operated in the interest of all investors, and not limited to select investors, sponsor, manager etc [to be ensured by the Manager]
Ensure timely and adequate dissemination of information to all investors
Ensure existence of effective risk management process and appropriate internal controls
Have written policies for mitigation of any potential conflict of interest
Prohibition on use of any unethical means to sell, market or induce any investor to buy its units
Have written policies and procedures to comply with anti-money laundering lawsnot offer any assured returns to any prospective investors/unitholders.
Manager of AIF
KMP of Manager
KMP of AIF
Abide by the laws applicable to AIFs at all times
Maintain integrity, highest ethical and professional standards in all its dealings
Ensure proper care and exercise due diligence and independent professional judgment in all its decisions
Act in a fiduciary capacity towards investors of AIF and ensure that decisions are taken in the interest of the investors
Abide by the policies of AIF in relation to potential conflict of interests
Not make any misleading or inaccurate statement, whether oral or written, either about their qualifications or capability to render investment management services or their achievements
Record in writing, the investment, divestment and other key decisions, together with appropriate justification for such decisions;
Provide appropriate and well considered inputs, which are not misleading, as required by the valuer to carry out appropriate valuation of the portfolio;
Prohibition on entering into arrangements for sale or purchase of securities, where there is no effective change in beneficial interest or where the transfer of beneficial interest is only between parties who are acting in concert or collusion, other than for bona fide and legally valid reasons;
Abide by confidentiality agreements with the investors and not make improper use of the details of personal investments and/or other information of investors;
Not offer or accept any inducement in connection with the affairs of or business of managing the funds of investors;
Document all relevant correspondence and understanding during a deal with counterparties as per the records of the AIF, if they have committed to the transactions on behalf of AIF
Maintain ethical standards of conduct and deal fairly and honestly with investee companies at all times; and
Maintain confidentiality of information received from investee companies and companies seeking investments from AIF, unless explicit confirmation is received that such information is not subject to any non-disclosure agreement.
Ensure availability of the PPM to the investors prior to providing commitment or making investment in the AIF and an acknowledgment be received from the investor
Ensure scheme-wise segregation of bank accounts and securities accountsnot offer any assured returns to any prospective investors/unitholders.
Members of Investment Committee
Trustee/ Trustee company
Directors of Trustee company
Directors of AIF
Designated Partners of AIF
Maintain integrity and the highest ethical and professional standards of conduct
Ensure proper care and exercise due diligence and independent professional judgment
Disclose details of any conflict of interest relating to any/all decisions in a timely manner to the Manager of the AIF, adhere with the policies and procedures of the AIF with respect to any conflict of interest and wherever necessary, recuse themselves from the decision making process;
Maintain confidentiality of information received regarding AIF, its investors and investee companies; unless explicit confirmation is received that such information is not subject to any non-disclosure agreement.
Not indulge in any unethical practice or professional misconduct or any act, whether by omission or commission, which tantamount to gross negligence or fraud
Not offer any assured returns to any prospective investors/unitholders.
Compliance with Stewardship Code
The AIFs, being institutional investors, it is mandatory for AIFs to comply with the Stewardship Code in terms of Para 13.4 of the AIF Master Circular. This is applicable in respect of investments in listed equity instruments. Annexure 10 of the Master Circular specifies the broad principles of stewardship and provides guidance for its implementation. Further, the AIFs are required to report the status of implementation of the principles atleast on an annual basis (periodicity may differ for different principles), through the website of the AIFs. Such report may also be sent as a part of annual intimation to its clients/ beneficiaries. An article on the stewardship responsibilities of institutional investors may be read here.
Policies to be formulated by AIFs
In order to ensure that the decisions of the AIF are taken in compliance with all applicable laws and regulations, PPM, investor agreements and other fund documents, detailed policies and procedures are required to be kept in place in terms of Reg 20(3). The policies are jointly approved by:
Manager and
Relevant governing body of the AIF (viz., the trustee/ trustee company/ board of directors/ designated partners etc)
The Manager is required to ensure that the decisions taken by the AIF are in compliance with such policies and procedures.
Further, the policies should be reviewed periodically, on a regular basis and whenever required as a result of business developments, to ensure their continued appropriateness.
Audit
Annual Audit of terms of PPM
The AIF is required to file Private Placement Memorandum (PPM) with SEBI through a Merchant Banker for the launch of Schemes. The format of PPM is specified under Annexure 1 read with the requirements specified under various other circulars from time to time. In order to ensure that the activities of the AIF are in compliance with the terms of PPM, annual audit of the terms of PPM is required to be done. In this regard, the following needs to be noted:
Scope of audit: Compliance with all sections of the PPM. Further, audit of the following sections is optional, viz., ‘Risk Factors’, ‘Legal, Regulatory and Tax Considerations’ and ‘Track Record of First Time Managers’. The format of PPM audit report may be accessed here.
Eligibility to conduct audit: an internal or external auditor/legal professional
Periodicity of PPM audit: Annual
Timeline: within 6 months from the end of the Financial Year
Reported to: Governing Body (Trustee or Board of Directors or Designated Partners) of the AIF, Board of directors or Designated Partners of the Manager and SEBI
Non-applicability: if no funds are raised from investors, subject to submission of a certificate from CA to that effect within 6 months from end of FY
Exemptions: (i) Angel Funds, (ii) AIFs/ Schemes with each investor having a minimum commitment of Rs. 70 crores (USD 10 mn or equivalent), upon providing a waiver for the same.
Audit of accounts
Reg 20(14) of the AIF Regulations require the books of account to be audited by a qualified auditor annually.
Valuation of Investments of AIF
Reg 23 read with Chapter 22 of the AIF Master Circular specifies the requirements with respect to the valuation of the investments of AIF. The valuation is required to be done by an independent valuer, on a half-yearly basis (may be made an annual requirement subject to consent of 75% of investors in value).
Eligibility criteria have been specified for acting as an independent valuer:
shall not be an associate of manager or sponsor or trustee of the AIF
shall have at least three years of experience in valuation of unlisted securities
shall be a registered valuer with IBBI and a member of ICAI, ICSI or ICMAI or shall be a holding or subsidiary of SEBI-registered CRA
The Manager shall specifically inform the investors, the reasons/ factors for deviation in valuation, in case the deviation is more than:
20% between two consecutive valuations, or
33% in a financial year
In case of Cat III AIFs, the listed and unlisted debt securities are required to be valued by an independent valuer, and the NAV is required to be reported on a quarterly basis for close ended funds, and monthly basis for open ended funds.
Investor complaints and Grievance Redressal Mechanism
Resolution of investor complaints is a role of the Manager of AIF [Reg 24 of AIF Regulations]. Reg 24A requires the Manager to redress investor grievances in a prompt manner, but within a maximum of 21 days from receipt of grievances. The AIF is required to be registered on the SCORES portal for receipt of investor grievances. Further, in terms of Reg 25, the dispute resolution mechanism provided by SEBI (SMARTODR) is applicable to AIFs as well. Refer details under Master Circular for Online Resolution of Disputes in the Indian Securities Market dated 28th December, 2023.
Further, in terms of Para 17.4 of the AIF Master Circular, the AIFs are required to maintain data on investor complaints received against the AIF/ its Schemes on a quarterly basis within 7 days from the end of the quarter, in addition to the disclosure in the PPM. The data includes the following:
S. No.
Investor Complaints received from
Pending as at the end of the last quarter
Received
Resolved
Total Pending at the end of the quarter
Pending complaints > 3months
Average Resolution time ^(in days )
1
Directly from Investors
2
SEBI (SCORES)
3
Other Sources
Matters requiring consent of investors of AIF
The AIFs act in a fiduciary capacity towards the investors, and manage the funds of the investors invested in the AIF. Thus, the decisions of AIF are required to be taken in the interests of the investors. Some matters require approval of the investors of a specified majority, prior to undertaking such activity:
Regulatory reference
Matter requiring approval
Requisite majority in terms of value of investment
Reg 9(2)
Material alteration to fund strategy
2/3rd of unitholders
Reg 13(5)
Extension of tenure of close-ended funds (upto 2 years)
2/3rd of unitholders
Reg 15(1)(e)
Investment in associates or units of AIFs managed/ sponsored by its Manager, Sponsor or associates of its Manager or Sponsor
75% of investors
Reg 15(1)(ea)
Purchase or sale of investments from/ to: Associates Schemes of AIF managed or sponsored by its Manager, Sponsor or associates of its Manager or Sponsoran investor who has committed to invest at least fifty percent of the corpus of the scheme of AIF
75% of investors, excluding investor covered under (c) where purchase/ sale is from such investor
Reg 20(10)
Appointment of external members (other than ex-officio members) in Investment Committee other than as disclosed in the fund documents
75% of investors
Reg 23(2)
Reducing frequency of valuation of investments from six months to 1 year
75% of investors
Reg 29(9)
In-specie distribution of investments of AIF due to lack of liquidity or enter into liquidation period
75% of investors
Disclosure to investors
The funds of the investors invested in the AIF are managed by the Manager and Sponsor in a fiduciary capacity. In order to ensure transparency, various disclosure requirements apply in terms of Reg 22 of the AIF Regulations – either on a periodic basis or upon the happening of certain events.
Periodic disclosures
The periodic disclosures include:
financial, risk management, operational, portfolio, and transactional information regarding fund investments
any fees ascribed to the Manager or Sponsor; and any fees charged to the AIF or any investee company by an associate of the Manager or Sponsor
Further, in terms of clause (g) of Reg 22, the following information is required to be disclosed within 180 days from the year end (60 days from the end of each quarter for Cat III AIF):
financial information of investee companies.
material risks and how they are managed which may include:
concentration risk at fund level;
foreign exchange risk at fund level;
leverage risk at fund and investee company levels;
realization risk (i.e. change in exit environment) at fund and investee company levels;
strategy risk (i.e. change in or divergence from business strategy) at investee company level;
reputation risk at investee company level;
extra-financial risks, including environmental, social and corporate governance risks, at fund and investee company level.
Any changes in terms of PPM or other fund documents are required to be intimated to the investors on a consolidated basis within 1 month from the end of each financial year [Para 2.5.3. of AIF Master Circular]
Event-based disclosures
These events are required to be disclosed ‘as and when occurred’:
any inquiries/ legal actions by legal or regulatory bodies in any jurisdiction
any material liability arising during the AIF’s tenure
any breach of a provision of the placement memorandum or agreement made with the investor or any other fund documents
change in control of the Sponsor or Manager or Investee Company
any significant change in the key investment team
Matters requiring reporting to SEBI
Reg 28 provides power to SEBI to seek such information from the AIFs, as may be required, from time to time. In addition to such powers, there are various specific reporting requirements that are applicable on AIFs under various applicable provisions. These include:
Regulatory reference
Matters requiring reporting to SEBI
Timelines
Reg 20(12)
Any material change from the information provided at the time of application
Promptly
Reg 26
Information for systemic risk purposes (including the identification, analysis and mitigation of systemic risks)
when so required by SEBI
Para 2.5.2
Any changes in the terms of PPM and other fund documents, along with DD certificate from Merchant Banker
Any violations reported in the Compliance Test Report (refer detailed discussion below)
As soon as possible
Reg 20(11) r/w Para 15.4.
Investments of AIF that are in custody of the custodian
Quarterly
Compliance with provisions applicable to SEBI-registered intermediaries
An AIF, in its capacity of a SEBI-registered intermediary, is required to comply with the SEBI (Intermediaries) Regulations, 2008 read with the circulars issued thereunder. These include, for instance, compliance with the circulars/guidelines as may be issued by SEBI with respect to KYC requirements, Anti-Money Laundering and Outsourcing of activities [Para 13.5 of AIF Master Circular].
The guidelines with respect to anti-money laundering and KYC requirements are contained in a Master Circular dated 6th June, 2024 on the subject. Our various resources on KYC and anti-money laundering can be accessed here.
Compliance Test Report
The manager of AIF is required to report the compliances with various applicable provisions of the AIF Regulations read with the circulars made thereunder, on an annual basis. CTR is submitted within 30 days from the end of the financial year, to the sponsor and trustee (in case AIF is set up as a trust). The trustee/ sponsor provides their comments on the CTR to the manager within 30 days from the receipt of CTR, based on which the manager shall make necessary changes and provide a response within the next 15 days.
A significant aspect of the CTR is that any violation observed by the trustee/ sponsor is required to be intimated to SEBI, as soon as possible. This requirement is in addition to the obligation of the Compliance Officer to report a non-compliance, within 7 days of becoming aware of the same. The format of CTR is provided in Annexure 12 of the AIF Master Circular.
Other compliances
SEBI specifies various compliances applicable to the AIFs from time to time. The compliances as applicable to the AIFs for the first time during FY 25-26 has been dealt with in our article Regulatory landscape for AIFs: what’s new? Further, there are certain requirements applicable on special categories of AIFs, viz., angel funds, Special Situation Funds, Social Venture Funds etc. Further, there are various prudential requirements applicable to receipt of funds from investors and making of investments by the AIFs.
Alternative Investment Funds (AIFs) have come up as a regulators’ favourite in the recent years with both SEBI and RBI tightening regulatory controls around the same within their respective domains. The use of AIF as regulatory arbitrage in recent years calls for such strict regulatory boundaries. The growth of AIFs appears quite decent, with statistics showing a cumulative investment of Rs. 5.38 lac crores made by AIFs, against Rs. 5.63 lac crores of funds raised (as on 31st March, 2025). Compared to the market size as at the end of 31st March, 2023, the market has grown by more than 50% as at the end of 31st March, 2025. Category II AIFs occupy the highest share, with Category III AIFs following suit. As the market size increases, so does the regulatory supervision.
This article deals with the regulatory requirements for AIFs that find their first-time mandatory applicability during FY 25-26, and would form a part of the Compliance Test Report (CTR) to be issued for FY 25-26 (see later part of this article).
Certification requirements for key investment team of Manager of AIF
Vide a 2023 amendment, the active schemes of AIFs as on 13th May, 2024 and those launched on or after 10th May, 2024 are required to have at least one key personnel in the key investment team of its Manager, with relevant certification as specified by SEBI. The NISM certification requirement, prescribed on 13th May, 2024, as extended, is required to be complied latest by 31st July, 2025.
Holding investments in dematerialised form
AIFs have been mandated to hold investments in dematerialised form, subject to certain relaxations. The timelines, as extended videcircular dated 14th February, 2025, attract dematerialisation requirements as below:
Date of investment by AIF
Applicability of dematerialisation
Inapplicability of dematerialisation
Dematerialisation to be ensured by
On or after 1st July, 2025
Mandatory
Scheme of an AIF whose: Tenure ends on or before 31st October, 2025 orExtended tenure as on 14th February, 2025
Immediately
Prior to 1st July, 2025
Not applicable, except: If investee company is mandated under applicable law to facilitate dematerialisation (for e.g. – CA, 2013 requires mandatory dematerialisation of shares except in case of small company or WoS of public company etc)AIF exercises control over the investee company, either on its own or along with other SEBI regd. intermediaries mandated to hold investments in demat form
On or before 31st October, 2025
Due diligence of investors and investments of AIF
An April 2024 amendment to the AIF Regulations, followed by a circular dated 8th October, 2024 read with the Implementation Standards formulated by the Standard Setting Forum for AIFs (‘SFA’) requires an AIF to carry out various due diligence checks through its Manager and its Key Management Personnel (KMP) with respect to investors and investments of the AIF, to prevent facilitation of circumvention of the specified regulatory frameworks. The scope and requirements for the due diligence has been detailed in our article and further elaborated in the form of FAQs (read here).
In addition to the ongoing due diligence requirements, a one-time due diligence was required for existing investments as on the date of the Circular (8th October, 2024), the report of which was required to be submitted to the custodian on or before 7th April, 2025.
Cybersecurity and Cyber Resilience Framework (CSCRF)
The Cybersecurity and Cyber Resilience Framework (CSCRF), notified vide the circular dated 20th August, 2024 as revised vide the circular dated 30th April, 2025, categorises AIFs based on the AUM at manager level. Accordingly, the following categorisation follows:
Corpus of all AIFs, VCFs and their schemes managed by a manager
Categorisation under CSCRF
> Rs. 10000 crores
Mid-size REs
3000 crores < AUM < 10000 crores
Small-size REs
< Rs. 3000 crores
Self-certification REs
The classification w.r.t. Qualified REs (the topmost categorisation) does not apply in case of AIFs.
The timeline for compliance with the requirements as per the CSCRF is 30th June, 2025 (as extended by the circular dated 28th March, 2025) based on which cyber audit is to be conducted from FY 25-26 and the report shall be submitted to SEBI.
Consequence of non-compliance: negative reporting in Compliance Test Report
The manager of AIF is required to report the compliances with various applicable provisions of the AIF Regulations read with the circulars made thereunder, on an annual basis. CTR is submitted within 30 days from the end of the financial year, to the sponsor and trustee (in case AIF is set up as a trust). The trustee/ sponsor provides their comments on the CTR to the manager within 30 days from the receipt of CTR, based on which the manager shall make necessary changes and provide a response within the next 15 days.
A significant aspect of the CTR is that any violation observed by the trustee/ sponsor is required to be intimated to SEBI, as soon as possible.
RBI, through a series of circulars (dated 19th December 2023 and 27th March 2024 respectively), regulates the investments made by the RBI-regulated entities in AIFs, putting a prohibition on the regulated entities from making investments in any scheme of AIFs which has downstream investments either directly or indirectly in a debtor company of such an entity. Draft Directions have been issued recently, proposing to permit investments by RBI-regulated entities upto a certain percentage of the corpus of the AIF scheme. Read more about the same here. Once notified, the same would relax the investment norms for RBI regulated entities in AIFs.
Further, SEBI has, in its meeting held on 18th June 2025, approved certain amendments for AIFs, particularly for angel funds. This aims to strengthen the regulatory regime around investments by angel funds considering the abolishment of angel tax in India, while also relaxing certain investment norms by such angel funds. Further, SEBI has approved co-investment schemes that may be offered by Cat I and Cat II AIFs, facilitating co-investment to accredited investors of a particular scheme of an AIF, in unlisted securities of an investee company where the scheme of the AIF is making investment or has invested. The AIF Regulations presently permits co-investments through a co-investment portfolio manager.
Thus, the approach of regulators seems to be gradually softening, attempting to bring a balance between regulatory supervision and ease of business considerations.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-06-21 18:54:072025-06-21 18:54:08Regulatory landscape for AIFs: what’s new?
The RBI has issued Draft Reserve Bank of India (Investment in AIF) Directions, 2025 (‘Draft Directions’), vide Press Release dated 19th May, 2025, marking a significant revision to the existing regulatory framework governing investments by regulated entities (REs) in Alternative Investment Funds (AIFs). These new directions, once finalised, will replace the existing circulars dated December 19, 2023 (“2023 Circular”), and March 27, 2024 (“2024 Clarification”) (collectively, referred to as “Existing Directions”), which currently govern such investments.
The Existing Directions prohibit REs from making investments in any scheme of AIFs which has downstream investments either directly or indirectly in a debtor company of the RE. In case of any such investment full provision is required to be maintained by the RE. Such prohibition is imposed to address the concerns of evergreening while making investments by an RE. See our analytical article on the same here.
However, the Draft Directions now propose to allow investment by the RE in such AIF upto 5% of the corpus of the AIF scheme. Any investment exceeding this 5% limit will require full capital if AIF has made debt investments in the debtor company. Note that these norms are entirely directed towards debt or debt instruments (whether at the RE level or the AIF level), as all sorts of equity instruments (equity shares, compulsorily convertible preference shares and compulsorily convertible debentures) are excluded – detailed discussion follows.
Comparison of Existing and Draft Directions
Below is a snapshot of what is going to change once the Draft Directions are finalised and notified, and certain important implications are discussed further:
Particulars
2023 Circular read with 2024 clarification
Draft Directions
Investment by REs in scheme of AIF
RE completely prohibited from investing in any scheme of AIF which has downstream investments in debtor company of the RE.Any investment already made had to be liquidated within 30 days of the issuance of the Circular. Similarly, where the RE had already invested, but AIF makes investment in a debtor company of RE, RE shall liquidate investments in AIF within 30 days.
To be allowed subject to individual and collective limits:Max. contribution of single RE to an AIF scheme – 10% of its corpusMax. contribution of multiple REs – 15% of its corpusSee illustrations later in this article.
Debtor company
Shall mean any company to which the RE currently has or previously had a loan or investment exposure anytime during the preceding 12 months.
Shall imply any company to which the RE currently has or previously had a loan or investment exposure (excluding equity instruments) anytime during the preceding 12 months.
Provisioning requirements
Inability to liquidate investments within 30-day liquidation period would entail 100% provisioning against such investments.
Investment by the RE in such AIF allowed upto 5% of the corpus of the AIF scheme, without looking into the form of downstream investments made by AIF. Hence, no provisioning required. If investment by RE exceeds 5%, it will require full capital, if downstream investments by AIF in debtor company are not permissible investments (see below). See illustrations later in this article
Provisioning required proportionately and not on entire investments
Provisioning is required only to the extent of investment by the RE in the AIF scheme which is further invested by the AIF in the debtor company, and not on the entire investment of the RE in the AIF scheme
Norms remain the same – RE shall be required to make 100 per cent provision to the extent of its proportionate investment in the debtor company through the AIF Scheme
Permissible forms of investments by AIF scheme in debtor company
Investment in equity shares (by AIF scheme in debtor company) were excluded from the prohibition by 2024 clarification. However hybrid instruments were still included.
All forms permitted, if investment by RE does not exceed 5%. Therefore, even debt investments by AIFs are permissible.Only equity shares, CCPS, and CCDs allowed, if investments by RE exceeds 5%. If AIF makes other forms of investments in debtor company, RE will have to provide for full capital.Note that, irrespective of the form of downstream investments by AIF in the debtor company, RE can take a maximum exposure of 10% in an AIF.
Priority distribution model
investment by REs in the subordinated units of any AIF scheme with a ‘priority distribution model’ shall be subject to full deduction from RE’s capital funds. Deduction shall be made from Tier I and II equally.
Norms remain the same.
Investment policy
No specific requirement
Investment policy to have suitable provisions to ensure that investments in an AIF Scheme comply, in letter and spirit, with the extant regulatory norms. In particular, such investments shall be subject to the test of evergreening.
Exemption by regulator
No specific enabling provision
Exempted category to be decided by RBI in consultation with GoI.
Illustrations on investment limits by RE
Below are certain illustrations to explain the implications of the investment thresholds under Draft Directions:
Scenarios
Implications under Draft Directions
Investment of Rs. 10 Crores by an RE in an AIF scheme having corpus of 50 crores
Cannot make since the threshold limit of 10% will be breached.
Investment of Rs. 5 Cr by an RE in an AIF scheme having corpus of 50 crores with other REs contributing Rs. 15 Cr
While the investment by the RE individually is within the limit of 10%, the collective investment is more than 15%. Hence, such an investment cannot be made by the concerned RE. Further, since the total investment of 15 cr by other REs will also breach the threshold of 15%, the investments will not be possible.
Investment of Rs. 5 Cr by an RE in an AIF scheme having a corpus of 50 Cr. The AIF in turn has a downstream debt investment in a debtor company of the RE.
Cannot be made since the limit of 5% will be breached.
Investment of Rs. 1 Cr by an RE in an AIF scheme having a corpus of 50 Cr. The AIF in turn has a downstream debt investment in a debtor company of the RE.
This constitutes only 2% of the corpus of the AIF scheme. Hence, permissible – even when the downstream investment of the AIF is a debt investment.
Investment of Rs. 5 Cr by an RE in an AIF scheme having a corpus of 50 Cr. The AIF in turn has a downstream equity investment in a debtor company of the RE.
Can be made as the downstream investment of the AIF is in equity of the debtor company. However, the maximum cap of 10% would apply to the RE.
Certain points of discussion/implications
Prospective applicability: The Draft Directions, once notified, will be applicable prospectively. It says, “These Directions shall come into force from the date of final issue (‘effective date’), substituting the existing circulars. Provided that, all outstanding investments as on the effective date, or subsequent drawdowns out of commitments made prior to the effective date, shall continue to be guided by the provisions of the existing circulars.” Therefore, no relaxations would be available to the existing investments/commitments by REs. If the same had not been liquidated so far – those will require to be liquidated. The Draft Directions will apply only to fresh investments by REs.
Maximum cap on investments by RE in AIF: Under Existing Directions, there is a blanket prohibition on RE to invest in AIF scheme which has invested in a debtor company. However, if such downstream investment is in equity shares, such prohibition would not apply. As such RE could invest in the said AIF without any limits. However, now, even if the AIF has invested only in equity instruments of the debtor company (equity shares, CCPS and CCDs), RE can only invest upto 10% of the corpus of the AIF scheme. Hence, to that extent, the Draft Directions are more restrictive than the Existing Directions. Note that, SEBI Circular on specific due diligence with respect to investors and investments of the AIFs does not provide any carve out for equity investments.
Exclusion of equity instruments (equity shares, CCDs and CCPS) from investment exposure of REs in the debtor company: Such exclusion is not explicitly there in the Existing Directions; which might have led to a possible interpretation that investment would include any nature of investment, including equity. Although, it was evident from the use of terminology that a debtor company would only mean a company where RE has extended only debt. The Draft Directions has clarified the same through explicit exclusion. Therefore, the directions will be applicable only where RE has investment in debt/debt instruments of the investee company.
Investments in AIF through intermediary funds: Existing directions exclude investments by REs in AIFs through intermediaries such as fund of funds or mutual funds from the scope of the directions. However, Draft Directions are silent on the same. We are of the view that such exclusion should continue to apply – as funds such as mutual funds are required to be well-diversified in terms of the SEBI Regulations, and investment decisions are taken by an independent investment manager.
Closing Remarks
We had earlier indicated that the Existing Directions may need to be reviewed and softened. The Draft Directions take a step in the same direction – however, a few concerns may still remain open. For instance, the Draft Directions retain the outreach of these restrictions to all AIFs, and not only affiliated AIFs. In our previous article, we had discussed how the concerns as to evergreening, etc. would arise mostly in cases involving affiliated AIFs, and not those AIFs which are completely unrelated to the RE..Further, no distinction has been made between various categories of AIF – therefore, investments in any AIF (Cat I, II, III) would be governed by these directions.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-05-22 18:04:552025-05-22 18:07:20Capital subject to “Caps”: RBI relaxes norms for investment by REs in AIFs, subject to threshold limits
