Table of Contents
Chapter 4: AIF Regulatory Framework
The primary legal charter governing the establishment, registration, capital raising, investment operations, and governance of Alternative Investment Funds in India is the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 (notified on May 21, 2012, and periodically amended). Every entity soliciting private capital for collective pooling must obtain prior registration from SEBI under these regulations.
Key Statutory Definitions Under Regulation 2(1)
- Alternative Investment Fund (AIF): Any fund established or incorporated in India in the form of a trust or a company or a limited liability partnership or a body corporate which:
- Is a privately pooled investment vehicle which collects funds from investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors; and
- Is not covered under the SEBI (Mutual Funds) Regulations, 1996, SEBI (Collective Investment Schemes) Regulations, 1999, or any other specialized intermediary regulations of the Board.
- Investible Funds: The total capital committed to the AIF by investors, net of estimated expenditure for administration, management of the fund, and fund setup expenses over the tenure of the fund.
- Corpus: The total amount of funds committed by investors to the Alternative Investment Fund by way of written contribution agreements or other binding instruments.
Core Registration and Eligibility Criteria (Regulation 4)
To grant an AIF registration certificate, SEBI evaluates strict fitness and institutional criteria across key entities:
- Constitutional Documents: The Trust Deed (for a Trust), LLP Agreement (for an LLP), or Memorandum and Articles of Association (for a Company) must explicitly prohibit the making of any invitation to the public to subscribe to its securities.
- Manager and Sponsor Competence: The Manager and Sponsor must be "fit and proper persons" under Schedule II of the SEBI (Intermediaries) Regulations, 2008. The key investment personnel of the Manager must possess requisite professional qualifications (finance, accountancy, or law) and at least five years of relevant experience in advising or managing investment pools or securities portfolios.
- Mandatory Continuing Interest (Sponsor Commitment): To ensure economic alignment ("skin-in-the-game"):
- Category I & Category II AIFs: The Sponsor or Manager must maintain a continuing interest of not less than 2.5% of the corpus or ₹5 Crore, whichever is lower.
- Category III AIFs: The continuing interest must be not less than 5% of the corpus or ₹10 Crore, whichever is lower.
- Angel Funds: Not less than 2.5% of the corpus or ₹50 Lakh, whichever is lower.
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| AIF INVESTMENT CONDITIONS COMPARISON |
+--------------------------+-------------------------------------+-----------------------------------+
| REGULATORY CONDITION | CATEGORY I & CATEGORY II AIFs | CATEGORY III AIFs |
+--------------------------+-------------------------------------+-----------------------------------+
| Permitted Investors | Maximum **1,000 investors** per | Maximum **1,000 investors** per |
| | scheme (Angel Funds: max 200). | scheme. |
+--------------------------+-------------------------------------+-----------------------------------+
| Minimum Ticket Size | **₹1 Crore** for standard investors;| **₹1 Crore** for standard; |
| | **₹25 Lakh** for employees/directors| **₹25 Lakh** for employees/mgrs. |
| | (Angel Funds: **₹25 Lakh**). | |
+--------------------------+-------------------------------------+-----------------------------------+
| Minimum Scheme Corpus | **₹20 Crore** across all schemes | **₹20 Crore** across all schemes |
| | (Angel Funds: **₹5 Crore**). | (closed or open-ended). |
+--------------------------+-------------------------------------+-----------------------------------+
| Single Investee Cap | Max **25%** of investible funds | Max **10%** of investible funds |
| (Diversification Limit) | in a single investee company. | in a single investee company. |
+--------------------------+-------------------------------------+-----------------------------------+
| Tenure of the Scheme | Strictly **Closed-Ended**; minimum | May be **Open-Ended** or |
| | tenure of **3 years**. | **Closed-Ended**. |
+--------------------------+-------------------------------------+-----------------------------------+
| Extension of Tenure | Up to **2 years**, subject to | Up to 2 years (for closed-ended), |
| | approval of 2/3rds of LPs by value. | subject to 2/3rds LP approval. |
+--------------------------+-------------------------------------+-----------------------------------+
Accredited Investor (AI) Framework
SEBI introduced the Accredited Investor regime to provide regulatory flexibility to ultra-wealthy, financially sophisticated participants:
- Eligibility Thresholds: Individuals with annual income $\ge$ ₹2 Crore, or net worth $\ge$ ₹7.5 Crore (with $\ge$ ₹3.75 Crore in financial assets). Entities/Corporates with net worth $\ge$ ₹50 Crore.
- Regulatory Relaxations for "Large Value Funds for Accredited Investors" (LVFs): If every investor in an AIF scheme is an Accredited Investor committing at least ₹70 Crore, the fund enjoys exemptions from standardized PPM requirements, can extend its tenure beyond the standard 2-year cap with LP consent, and can negotiate bespoke bilateral terms.
Alternative Investment Funds are critical channels for foreign capital mobilization. Cross-border capital inflows into Indian AIFs are regulated under the Foreign Exchange Management Act (FEMA), 1999, administered by the Reserve Bank of India (RBI) through the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 ("NDI Rules").
1. Inbound Foreign Investment into AIFs (Rule 16 of NDI Rules)
- A person resident outside India (including Non-Resident Indians [NRIs], Foreign Portfolio Investors [FPIs], and foreign corporate entities) is permitted to subscribe to units of an Indian AIF on a fully repatriable basis under the automatic route.
- Foreign investments in AIF units must comply with sectoral caps, pricing guidelines, and reporting obligations specified by the RBI and the Department for Promotion of Industry and Internal Trade (DPIIT).
2. Downstream Investment Rules (The FOCC Test)
When an Indian AIF containing foreign capital invests downstream into domestic portfolio companies, the regulatory character of that investment is determined by the Foreign Owned or Controlled Company (FOCC) principle:
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| DOWNSTREAM INVESTMENT (FOCC) TEST |
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| |
| Is the Sponsor AND the Investment Manager of the AIF: |
| "Owned and Controlled by Resident Indian Citizens"? |
| |
| / \ |
| YES NO |
| v v |
| +----------------------------------+ +------------------------------------+ |
| | DOMESTIC INVESTMENT STATUS | | INDIRECT FOREIGN INVESTMENT | |
| | The AIF's investments into | | The entire investment into the | |
| | domestic investee companies are | | portfolio company is treated as | |
| | treated as purely DOMESTIC | | INDIRECT FOREIGN INVESTMENT. | |
| | capital, regardless of foreign LP| | Must comply with sectoral caps, | |
| | capital percentage in the fund! | | entry routes & performance norms. | |
| +----------------------------------+ +------------------------------------+ |
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- Ownership Test: More than 50% of the capital or beneficial interest in the Manager/Sponsor entity must be held by resident Indian citizens.
- Control Test: The power to appoint a majority of directors or control management and policy decisions must reside with resident Indian citizens.
3. Outbound Investments by Indian AIFs
SEBI-registered AIFs are permitted to invest up to 25% of their investible funds in overseas companies or securities incorporated outside India, subject to an overall industry-wide cap allocated by SEBI and the RBI. The overseas investee company must have an equity presence in India or demonstrate a substantial economic nexus with India.
Alternative Investment Funds operate under strict anti-money laundering and investor protection mandates, preventing illicit capital from penetrating private markets while establishing transparent dispute resolution mechanisms.
PMLA Compliance and Beneficial Ownership Due Diligence
Under the Prevention of Money Laundering Act (PMLA), 2002 and SEBI KYC Master Directives, AIF Managers and Trustees are designated reporting entities with statutory compliance obligations:
- Client Due Diligence (CDD): The AIF must verify the identity, legal status, permanent account number (PAN), and residential/registered address of all investors prior to accepting subscription monies.
- Identification of Ultimate Beneficial Owner (UBO):
- For Companies: Any natural person holding, directly or indirectly, more than 10% of shares, capital, or profits.
- For Partnership Firms / LLPs: Any natural person holding more than 10% of capital or profits.
- For Trusts: The author/settlor, trustee, protector, and beneficiaries with $\ge$ 10% interest, plus any other natural person exercising ultimate effective control over the trust.
- Politically Exposed Persons (PEPs): Enhanced due diligence (EDD) must be conducted for investors classified as PEPs (foreign heads of state, senior politicians, judicial or military officials) and their immediate family members.
Investor Redressal: SEBI SCORES and SMART ODR
SEBI provides a comprehensive digital grievance redressal architecture:
- SCORES (SEBI Complaints Redress System): An online portal where AIF investors can lodge complaints against Managers or Trustees. The entity must resolve the complaint within 21 calendar days.
- SMART ODR (Securities Market Approach to Resolution Through ODR Portal): A digital dispute resolution platform integrating online conciliation and independent arbitration. If an investor dispute remains unresolved via the internal grievance cell or SCORES, the investor can initiate online arbitration on the SMART ODR portal, where legally binding arbitral awards are rendered under the Arbitration and Conciliation Act, 1996.