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
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
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-12-02 11:01:512026-01-07 14:56:59Private Credit AIFs: Lenders of Last Resort?
The 2025 Amendments to the AIF Regulations has brought substantive changes to the regulatory landscape for angel funds, moving the same as a category of Cat I Funds, as against a sub-category of Venture Capital Funds. However, regulatory oversight strictens, with the access exclusively limited to accredited investors only. In view of the redundancy of a “scheme” in the context of angel funds (see below), the same has been omitted and replaced with each investment based participation of investors.
Angel Funds, a unique type of start-up friendly investment vehicle, was formally recognised by SEBI in the year 2013 with the introduction of Chapter III-A to the SEBI (Alternative Investment Funds) Regulations, 2012. As on 31st March 2025, there are 103 registered Angel Funds with a total commitment of Rs. 10,138 crores. The regulatory landscape for angel funds has been substantially revamped with the notification of SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2025, dated 8th September, 2025. The Amendment Regulations are further supplemented with a Circular dated September 10, 2025 prescribing the specific conditions and modalities pertaining to the provisions applicable to Angel Funds.
The amendments are based on the Consultation Paper dated 13th November, 2024, released post the Union Budget announcement of abolishment of angel tax (see a brief presentation here), for operational clarity and strengthening the governance and disclosure requirements for angel funds.
Uniqueness of structure
The uniqueness of Angel Funds lie in its structure. Unlike a typical AIF, in the case of Angel Funds, the investors provide specific consent to each investment opportunity. As such, there is no proportionality between the contribution of the investors in a scheme of AIF vis-a-vis the indirect contribution made in an investee company by such AIF scheme. As such, as against the usual “scheme” structure, an Angel Fund follows an “investment” structure.
Applicability
The Amendment Regulations are effective from the date of publication of the same in the Official Gazette, viz., 8th September 2025. The Circular was issued on 10th September, 2025. Further, in order to facilitate transition of the existing Angel Funds, additional timeline has been provided for compliance in some cases.
Exclusive to AIs: eligibility to act as an angel investor
Pursuant to the amendments, it is only an Accredited Investor who is eligible to be onboarded as an angel investor in an angel fund. The difference between the eligibility conditions are tabulated below:
Particulars
Angel Investors (Erstwhile Framework)
Accredited Investors (Amended Framework)
Categories of investors
Individual/Body corporate/AIF/ VCF
IndividualHUF Family trust Sole proprietorship Body corporate Trust other than family trust Partnership firm Government, Govt development agencies, QIBs, FPIs, Sovereign Wealth Funds etc – exempt from accreditation requirement
Eligibility criteria
In case of individual, Net tangible assets > Rs. 2 crs (excluding principal residence) andHas experience of Early stage investment or Serial entrepreneur or SMP with at least 10 years’ experience
In case of 1 to 4, either of the following: Annual income > Rs. 2 crs or Net worth > Rs. 7.5 crs out of which at least Rs. 3.75 crs is in the form of financial assets.Annual Income ≥ Rs. 1 cr + Net Worth ≥ Rs. 5 crs, out of which at least Rs. 2.5 crs is in the form of financial assets.In case of 7, each partner to separately meet aforesaid criteria
In case of body corporate, networth > Rs. 10 crs
In case of body corporate, networth > Rs. 50 crs
Trust other than family trust, networth > Rs. 50 crs
Independent accreditation
Not applicable
Applicable
Not only the eligibility conditions are stringent in case of AIs as compared to erstwhile concept of angel investors, but the mandatory “accreditation” criteria would be a primary factor that may lead to elimination of many investors who were earlier eligible for acting as an angel investor.
Transition period
For angel funds registered on or before 10th September 2025 (the date of issue of Circular), a timeline of 1 year, that is, upto 8th September 2026 has been specified, for transition into the new framework. During this period, offers can be made to upto 200 non-AIs.
No new contribution can be accepted from non-AIs post 8th September, 2026, though the investors continue to hold their existing investments already made in the angel fund.
Regulatory regime for Angel Funds: old v/s new
Topic
Old Framework
New Framework
Rationale
STRUCTURE OF THE FUND
Category of AIF [Reg 19A(1)]
Sub-category of VCF under Cat -I
Sub-category of Cat – I
In view of the unique features of Angel Funds as compared to VCFs. See differences below
Schemes under Fund [Reg 19E]
Allowed
Not allowed
Since there is practically no distinction between a “scheme” and an “investment” in the context of an angel fund, hence, the concept of scheme is not relevant for an angel fund.
Filing of placement memorandum with SEBI [Reg 19D(4)]
Not applicable
PPM to be filed along with application for registration through merchant banker for comments of SEBI
Previously, term sheets for each Schemes were filed with SEBI for “informational” purposes. The requirement has been substituted with filing of PPM at the time of registration itself.
Filing of the term sheet for schemes with SEBI [Reg 19E]
Mandatory, 10 days from launch of scheme
Not applicable
Term sheet is filed for material information of each Scheme, not relevant since scheme structure is omitted for angel funds
Minimum continuing interest of Sponsor/ Manager [Reg 19G]
2.5% of corpus or Rs. 50 lacs, whichever is lower
0.5% of investment amount or Rs. 50,000, in each investee, whichever is higher
To ensure that manager/sponsor has interest in every investment
INVESTMENT IN ANGEL FUND
Eligibility of investor [Reg 19D(1)]
Angel Investor based on certain eligibility conditions specified therein (see later in this article)
Accredited Investor KMP of Angel Fund/ Manager
To ensure proper verification of the risk appetite and informed decision making capabilities of the investor, since investment in start-ups are highly risky. To enhance skin in the game
Minimum corpus [Reg 19D(2)]
Rs. 5 crore
NA
NA since each investment is based on prior consent of investor, the concept of a common corpus is irrelevant
Minimum investment per investor [Reg 19D(3)]
Rs. 25 Lakhs
NA
No minimum limit since only AIs are allowed to invest
Minimum number of investors [Reg 19D(6)]
Not specified
At least 5 AIs prior to disclosing first close
To ensure sufficient investor interest prior to starting to make investments, in the absence of any minimum corpus requirement.
Maximum number of investors
200 in a scheme [Reg 19E(2) – omitted]
No limit
Since only AIs are eligible who are independently verified, sufficient guardrails exist. No cap on number of investors facilitate scaling up of the industry and enhance capital flow to start-ups. Further, ICDR Regulations have been amended to include AIs within the meaning of QIBs for the purpose of investment in angel funds, accordingly, the limit of 200 as per section 42 of the Companies Act, 2013 shall also not apply in case the AIF is formed as a company.
INVESTMENT BY ANGEL FUNDS
Prohibition from investment in certain investees [Reg 19F(6)]
Companies with family connection with any of the angel investors.
No investments from such investors who are related party to an investee
See below.
Follow-on investment in existing investee [proviso to Reg 19F(1)]
Not permitted once the investee ceases to be start-up
Allowed subject to the condition that the Fund’s post-issue shareholding percentage does not exceed pre-issue shareholding percentage
To protect and preserve the value of the existing investments of Angel Funds in an investee. Investment cap is to ensure that while pre-emptive rights can be exercised by angel funds, does not result in dilution of the regulatory intent behind angel funds
Minimum investment in an investee [Reg 19F(1)]
Rs. 25 Lakhs
Rs. 10 Lakhs
The increase in range is to reflect the growth of angel ecosystem, providing more flexibility to the Angel Funds
Maximum investment in an investee [Reg 19F(1)]
Rs. 10 crores
Rs. 25 crores (including upon follow-on investment)
Lock-in on investments [Reg 19F(3)]
1 year
6 months – if sold to a third party subject to AoA of investee. 1 year – in other cases, including buyback, sale to promoters of investee/ associates of promoters
To maintain stability of investments while providing flexibility of favourable exit to the angel fund
Minimum number of AIF investors in each investee [Reg 19F(5)]
No such limit
2 investors
Also serves as a check against misuse of angel fund structure for facilitating investments from single investor
COMPLIANCES APPLICABLE TO ANGEL FUNDS
Exception from application of certain provisions of the Regs [19B (2)]
Reg 10(a), (b), (c), (d), (f) – Conditions w.r.t. Investment in AIFReg 12 – Filing of Scheme Reg 14 – Listing of unitsReg 15(1)(a), (c), (e) – Conditions w.r.t. Investment by AIFReg 16(1)(b) – OmittedReg 16(2) – Additional conditions applicable to VCFsReg 20(21) – Rights of investors pro rata to their contribution
Following additional exceptions: Reg 15(da) – AIFs making investments through multiple layers of AIFsReg 16(1)(a) – Types of investeeReg 17 – Conditions for Cat II investments Reg 18 – Conditions for Cat III investments
The exceptions are majorly in alignment with the non-Scheme structure of the Angel Funds
Annual audit of compliance with terms of PPM
Not applicable
Mandatory, if total investment (at cost) exceeds Rs. 100 crs
Exemption to continue for smaller Angel Funds, larger Angel Funds be subject to audit of PPM
Reporting in relation to performance benchmarking
Not applicable
Applicable from FY 25-26
To improve transparency
Related Party v/s Family Connection
Angel Funds are not permitted to accept contributions from such investors, who are related parties to the investee company in which the investment is to be made. Here, the definition of “related party” is to be taken from Reg 2(1)(zb) of SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015. The definition, in turn, refers to Companies Act and applicable accounting standards as well.
Various questions arise:
Who prepares the list of related parties as per LODR definition? Is it the prospective investee that is responsible?
Can the investment manager and investor be absolved of their responsibilities of verification of whether or not the investor is a related party to the investee?
What if the investor becomes a related party of the investee entity, subsequent to making such investments?
The change from the term “family connection” to “related party” seems to simplify the identification for the prospective investee company, since such companies would have already identified related parties in terms of section 2(76) of CA, 2013 and applicable accounting standards. The only additional categories for such investees would be:
Promoters and members of promoter group, and
Shareholders holding 10% or more equity shares in the company on a beneficial interest basis.
Concluding Remarks
The amended regulatory framework makes it stringent for angel funds to raise funds from angel investors, restricting the access to accredited investors only. With the limited number of investors “accredited” registered in India (649 as on May 2025), early stage start-ups might face obstacles in startup funding. While SEBI has proposed ease of accreditation requirements, the same has not been made effective yet. As on 30th June 2025, data shows that the number of VCFs are much higher than the number of angel funds, and with the amended requirements, it might so happen that the investors would prefer VCFs over angel funds, as a means of investing in start-ups.
https://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.png00Staffhttps://vinodkothari.com/wp-content/uploads/2023/06/vinod-kothari-logo.pngStaff2025-10-04 15:55:452025-10-10 12:12:52Angel Funds 2.0: Navigating the New Regulatory Landscape
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?
Since its introduction in 2021, the concept of Accredited Investors (AIs) has been through some changes. A Consultation Paper was published on 17th June, 2025 to provide for certain flexibilities in the accreditation framework. Another Consultation Paper dated 8th August 2025(‘AI CP’) proposed to bring light-touch regulations for AIF schemes seeking investments from only AIs, including extension of various exemptions to such schemes, that are currently available to Large Value Funds (LVFs).
Further, vide another Consultation Paper(‘LVF CP’), some relaxations were also proposed to be extended to Large Value Funds (LVFs) for AIs. Note that the LVFs are available only for AIs, and hence, the Amendment Regulations define the AIs-only schemes to include LVF.
The SEBI (Alternative Investment Funds) (Third Amendment) Regulations, 2025 has been notified on 18th November, 2025, thus introducing the concept of AI-only schemes in the regulatory framework. Note that, vide the 2nd Amendment Regulations, the angel funds have also been exclusively restricted to Accredited Investors only. See an article on the Angel Funds 2.0: Navigating the New Regulatory Landscape.
Accredited Investors – who are they?
An AI is considered as an investor having professional expertise and experience of making riskier investments. Reg 2(1)(ab) of AIF Regulations defines an accredited investor as any person who is granted a certificate of accreditation by an accreditation agency, and specifies eligibility criteria. The eligibility criteria is as follows:
Further, certain categories of investors are deemed to be AIs, that is, certificate of accreditation is not required, such as, Central and State Governments, developmental agencies set up under the aegis of the Central Government or the State Governments, sovereign wealth funds and multilateral agencies, funds set up by the Government, Category I foreign portfolio investors, qualified institutional buyers, etc.
‘Accreditation’ as a measure of risk sophistication
AIFs are investment vehicles pooling funds of sophisticated investors, and not for soliciting money from retail investors. The measure of sophistication, as specified in the AIF Regulations currently, is in the form of the ‘minimum commitment threshold’. Reg 10(c) of the Regulations require a minimum investment of Rs. 1 crore, except in case of investors who are employees or directors of the AIF or of the Manager.
There are certain shortcomings of considering the minimum commitment threshold as the metric of risk sophistication of an investor, such as:
May not necessarily lead to an actual draw-down, thus exposing to the risk of onboarding investors with inflated commitments. As per the data available on SEBI’s website, out of the total commitment of Rs. 13 lac crores for the quarter ended 31st March 2024, only about Rs. 5 lac crores worth of funds were actually drawn down. Similarly, for the quarter ended 31st March 2025, the value of commitment vis-a-vis funds raised
Does not consider the investor’s financial health (income, net worth etc), hence, a potential risk of the investor putting majority of its wealth in AIFs, a riskier investment class.
The concept of AIs, as proposed in February 2021, was to introduce a class of investors who have an understanding of various financial products and the risks and returns associated with them and therefore, are able to take informed decisions regarding their investments. Accreditation of investors is a way of ensuring that investors are capable of assessing risk responsibly.
The June 2025 CP indicated that it is being examined to move AIFs gradually in an exclusively for AIs approach, starting with investments in angel funds and in framework for co-investing in unlisted securities of investee companies of AIFs. Accordingly, the present CP has proposed a gradual and consultative transition from ‘minimum commitment threshold’ to ‘accreditation status’ as a metric of risk sophistication of an investor.
Flexibility for AIs-only schemes vis-a-vis other AIFs
The accreditation status is to be ensured at the time of onboarding of investors only. Therefore, if an investor subsequently loses the status of AI in interim, the same shall still be considered as an AI for the AI only scheme, once on-boarded. The following relaxations have been extended to AIs-only schemes, in order to provide for a light-touch regulatory framework, from investor protection viewpoint, considering that the AIs have the necessary knowledge and means to understand the features including risks involved in such investment products:
This facilitates differential rights to different classes of investors within a scheme.
Extension of tenure of close-ended funds [reg 13(5)]
up to two years subject to approval of two-thirds of the unit holders by value of their investment in AIF
This facilitates a longer tenure extension to an existing close-ended scheme, if suited to investors.
However, it is further clarified that the maximum extension permissible to such AI only schemes, inclusive of any tenure extension prior to such conversion, shall be 5 years.
Certification criteria for key investment team of Manager [reg 4(g)(i)]
Atleast one key personnel with relevant NISM certification
The investors, being accredited, the reliance on key investment team of the Manager is comparatively low.
Further, in case of AIs-only Funds, the responsibilities of Trustee as specified in Reg 20 r/w the Fourth Schedule shall be fulfilled by the Manager itself. This is based on the premise that, the investors, being accredited, the reliance on Trustee for investor protection is comparatively low.
Large Value Funds: a sub-category of AIs only scheme
The concept of LVF was also introduced in 2021, along with the concept of AIs. An LVF, in fact, is an AIs only fund, with a minimum investment threshold. Reg 2(1)(pa) of the AIF Regulations defines LVF as:
“large value fund for accredited investors” means an Alternative Investment Fund or scheme of an Alternative Investment Fund in which each investor (other than the Manager, Sponsor, employees or directors of the Alternative Investment Fund or employees or directors of the Manager) is an accredited investor and invests not less than seventy crore rupees.
Since an LVF is included within the meaning of an AIs-only scheme, all exemptions as available to an AIs only scheme, are naturally available with an LVF, although the converse is not true.
Additional Exemptions available to LVFs (other than as available to AIs only scheme)
In addition to the relaxations extended to an AIs only scheme, there are additional exemptions available to an LVF. These are:
Regulatory reference
Topic
Exemption for LVF
Reg 12(2)
Filing of placement memorandum through merchant banker
Not applicable
Reg 12(3)
Comments of SEBI on PPM through merchant banker
Not applicable, only filing with SEBI required
Reg 15(1)(c)
Investment concentration for Cat I and Cat II AIFs – cannot invest more than 25% of investable funds in an investee company, directly or through units of other AIFs
May invest upto 50% of investable funds in an investee company, directly or through units of other AIFs
Reg 15(1)(d)
Investment concentration for Cat III AIFs – cannot invest more than 10% of investable funds in an investee company, directly or through units of other AIFs
May invest upto 25% of investable funds in an investee company, directly or through units of other AIFs
Reduction in minimum investment size for LVFs
The minimum investment threshold for investors in LVF has been reduced from Rs. 70 crores to Rs. 25 crores, based on the recommendations of SEBI’s Alternative Investment Policy Advisory Committee (AIPAC). The rationale is to lower entry barriers to facilitate improved fund raising, without compromising on the level of investor sophistication. The reduction of investment thresholds would also facilitate investments by regulated entities having a strict exposure limit, such as insurance companies.
Exemptions from requiring specific waivers for certain provisions
The extant regulations permitted that 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.
The requirement of specific waiver has been omitted for LVFs considering that AIs are already required to provide an undertaking for the purpose of availing benefits of ‘accreditation’. The undertaking, as per the format given in Annexure 8 of the AIF Master Circular states the following:
(i) The prospective investor ‘consents’ to avail benefits under the AI framework.
(ii) The prospective investor has the necessary knowledge and means to understand the features of the investment Product/service eligible for AIs, including the risks associated with the investment.
(iii) The prospective investor is aware that investments by AIs may not be subject to the same regulatory oversight as applicable to investment by other investors.
(iv) The prospective investor has the ability to bear the financial risks associated with the investment.
Similarly, LVFs have been exempt from following the standard PPM template without the requirement of obtaining specific waiver from investors.
Migration of existing eligible AIFs
One of the proposals of the LVF CP is to permit eligible AIFs, not formed as an LVF, to convert themselves into an LVF and avail the benefits available to LVF schemes. The conversion shall be subject to obtaining positive consent from all the investors. Following the same, the modalities for such migration has been specified by SEBI vide circular dated 8th December, 2025.
Pursuant to such migration, the AIF manager shall ensure that:
Name of the converted scheme contains ‘AI only fund’ or ‘LVF’ as the case may be
Such conversion and change in name to be reported to SEBI within 15 days through dedicated email ID
Such change in name to be reported to depositories within 15 days of conversion
Limit on maximum number of investors
Reg 10(f) puts a cap on the maximum number of investors in a scheme. Pursuant to the Amendment Regulations, the cap of 1000 investors shall not include the AIs.
In practice, the number of investors in an AIF is much lower than 1000, and hence, the amendment may not have much of a practical relevance.
Conclusion
The amendments are a step towards providing a lighter regulatory regime for AIFs, meant for sophisticated investors, capable of making well-informed decisions. The move is expected to witness more schemes focussed on AIs only, and thus, bring an AIs only regime for AIFs. In order to differentiate an AIs only scheme or an LVF from other AIF schemes, it is mandatory for the newly launched schemes henceforth to have the words ‘AI only fund’ or ‘LVF’ as the case maybe.
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
