Chapter 14: Regulatory Framework
Core Statutory Provisions under SEBI AIF Regulations
The regulatory framework governing Alternative Investment Funds in India is codified under the SEBI (Alternative Investment Funds) Regulations, 2012:
| Regulatory Parameter | Statutory Limit / Mandate |
|---|---|
| Minimum Scheme Corpus | ₹20 Crores (₹5 Crores for Angel Funds) |
| Minimum Investor Commitment | ₹1 Crore (₹25 Lakhs for Employees/Angels) |
| Maximum Number of Investors | 1,000 investors (200 for Angel Funds) |
| Sponsor / Manager Commitment | 2.5% of corpus or ₹5 Crores (lower) |
| Single Investee Concentration Cap | Max 25% of investable funds |
| Mandatory Dematerialization | All AIF units must be in demat form |
| Direct Plan Option | Mandatory direct plan (zero commission) |
Borrowing and Leverage Restrictions for Category I and II AIFs
Under Regulation 16(1)(c) and Regulation 17(c), Category I and Category II AIFs are strictly prohibited from borrowing funds or engaging in leverage, directly or indirectly, except for meeting temporary funding shortfalls:
- Permitted Purpose: Meeting operational expenses or funding drawdown shortfalls from defaulting investors.
- Tenure Limit: Maximum duration of 30 days.
- Quantum Limit: Not more than 10% of the investable funds.
- Frequency Limit: Not more than 4 times in a calendar year.
Mandatory Dematerialization of Units
SEBI mandates that all Category I and II AIFs must issue units exclusively in dematerialized (demat) form through registered depositories (NSDL / CDSL). This enhances transparency, eliminates physical certificate reconciliation errors, and facilitates seamless audit tracking.
Cross-Border Capital and the FOCC Framework
Foreign capital flowing into Indian AIFs and downstream deployment by AIFs into portfolio companies is governed by the Foreign Exchange Management (Non-Debt Instruments) Rules, 2019:
Key Guidelines & Structure
- Downstream Investment FOCC Test:
- Indian AIF Receiving
- Foreign Capital
- ▼ ▼
- [Manager & Sponsor BOTH are] [Manager OR Sponsor is]
- [Indian Owned and Controlled] [Foreign Owned or Controlled (FOCC)]
- ▼ ▼
- Downstream Investment treated as Downstream Investment treated as
- DOMESTIC INVESTMENT FOREIGN INVESTMENT
- (Not subject to FDI caps/rules) (Must comply with FDI sectoral caps,
- pricing guidelines & performance cond.)
Ownership and Control Test (FOCC)
- Indian Owned: More than 50% of the capital/equity interest is held beneficially by Indian resident citizens or Indian companies owned and controlled by resident citizens.
- Indian Controlled: The right to appoint a majority of directors or to control management and policy decisions rests with resident Indian citizens.
- Regulatory Impact: If both the Manager and the Sponsor of the AIF are Indian Owned and Controlled, the downstream investments made by the AIF are considered pure domestic investments, even if 99% of the fund’s LPs are offshore foreign investors!
Inter-Regulatory Compliance Architecture
Alternative Investment Fund Managers operate under an overlapping web of statutory integrity, insider trading, and anti-money laundering mandates:
| AIF Statutory Compliance Web | Details 2 | Details 3 | Details 4 | Details 5 |
|---|---|---|---|---|
| PMLA / KYC Regulations | SEBI (PIT) Regulations | SEBI (PFUTP) Regulations | ||
| • Beneficial Ownership (UBO) | • Structured Digital Database | • Prohibition of Fraudulent | ||
| threshold: 10% | (SDD) with timestamps | and Unfair Trade Practices | ||
| • Screening against PEPs | • Trading windows & UPSI | • Ban on circular trading and | ||
| • Suspicious reporting (STR) | handling protocols | misleading statements |
1. Prevention of Money Laundering Act (PMLA, 2002)
- Managers must implement stringent Client Due Diligence (CDD) procedures.
- Ultimate Beneficial Owner (UBO): Must identify natural persons who exercise ultimate ownership (>10% equity/profit interest in companies/trusts) or operational control.
- Ongoing screening against UN/OFAC sanctions lists and reporting of Suspicious Transaction Reports (STRs) to the Financial Intelligence Unit - India (FIU-IND).
2. SEBI Prohibition of Insider Trading (PIT) & Structured Digital Database (SDD)
- AIF investment teams frequently acquire Unpublished Price Sensitive Information (UPSI) during due diligence on listed investee companies or when preparing private portfolio companies for an IPO.
- The Manager must maintain a tamper-proof Structured Digital Database (SDD) internally with non-volatile date/time stamps capturing the name and PAN of persons with whom UPSI is shared.
3. Online Dispute Resolution (SMART ODR Platform)
- All AIFs are integrated into SEBI’s streamlined Securities Market Approach to Resolution Through ODR Portal (SMART ODR).
- Investor grievances unresolved through the internal conciliation process or SEBI SCORES are escalated to independent institutional arbitrations under SMART ODR.
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