Table of Contents
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:
Key Statutory Operational Parameters (Cat I & II AIFs):
┌──────────────────────────────────────┬──────────────────────────────────────────┐
│ 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:
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 │
└───────────────────┬────────────────────┘
│
┌───────────────────────────────────────┼───────────────────────────────────────┐
▼ ▼ ▼
┌──────────────────────────────┐ ┌──────────────────────────────┐ ┌──────────────────────────────┐
│ 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.