Chapter 4: Alternative Investment Fund Ecosystem

Structural Participants in the AIF Operating Machine

An Alternative Investment Fund functions through an interconnected ecosystem of fiduciary, administrative, investment management, and custodial intermediaries governed by statutory contracts:

                            ┌────────────────────────────────────────┐
                            │               SETTLOR                  │
                            │  Establishes Trust with nominal corpus │
                            └───────────────────┬────────────────────┘
                                                │
                                                ▼
                            ┌────────────────────────────────────────┐
                            │               TRUSTEE                  │
                            │  Legal Owner of Assets; Fiduciary Duty │
                            └───────┬────────────────────────┬───────┘
            Appoints Manager        │                        │ Custody of Securities
                   ┌────────────────┘                        └────────────────┐
                   ▼                                                          ▼
┌──────────────────────────────────────┐                   ┌──────────────────────────────────────┐
│          INVESTMENT MANAGER          │                   │              CUSTODIAN               │
│ • Investment Decisions & Execution   │                   │ • Safekeeping of Fund Securities     │
│ • Deal Sourcing & Due Diligence      │                   │ • Demat / Physical Vaulting          │
│ • Portfolio Monitoring & Reporting   │                   │ • Mandatory for all Cat I & II AIFs  │
└──────────────────┬───────────────────┘                   └──────────────────────────────────────┘
                   │
    ┌──────────────┴──────────────┐
    ▼                             ▼
┌───────────────────────┐   ┌───────────────────────┐
│      SPONSOR          │   │  INVESTMENT COMMITTEE │
│ • Promotes the Fund   │   │ • Approves investments│
│ • Skin-in-the-game    │   │ • Fiduciary liability │
└───────────────────────┘   └───────────────────────┘

Roles and Fiduciary Responsibilities

The Settlor: Initiates the establishment of the fund by executing the Indenture of Trust and transferring a nominal initial settlement amount (typically ₹10,000 to ₹1,00,000) to the Trustee.
The Trustee: Holds the legal title to all fund assets in trust for the collective economic benefit of the contributors (unit-holders/LPs). The Trustee oversees fund governance, ensures adherence to the Trust Deed and PPM, and exercises fiduciary oversight over the Investment Manager.
The Investment Manager (AMC): The operational entity contracted via the Investment Management Agreement (IMA) to manage the fund's investment operations, portfolio company monitoring, valuation coordination, and eventual investor exits.
The Sponsor: The entity or promoter initiating the formation of the AIF, legally obligated to maintain a continuous, unencumbered skin-in-the-game commitment (2.5% of corpus or ₹5 Crores for Cat I & II).
The Custodian: An independent SEBI-registered entity mandated to maintain safe custody of the fund’s securities, dematerialized units, and underlying share certificates. Mandatory for all AIFs with corpus >₹500 Crores, and now universally required across Category I & II AIFs.
Registrar and Transfer Agent (RTA): Manages the unit-holder registry, processes capital calls and drawdown notices, executes unit allotments, handles KYC/AML verification, and issues periodic capital account statements.
Independent Registered Valuer: Empanelled professionals registered with the Insolvency and Bankruptcy Board of India (IBBI) responsible for independent, semi-annual/annual valuation of unlisted portfolio investments.

Capital Calling Mechanics in Closed-End Funds

Unlike open-ended mutual funds where investors inject capital in full upfront, Category I and II AIFs operate on a committed capital and staged drawdown architecture:

Capital Call Workflow:
[Commitment Signed] ──> [Drawdown Notice Issued] ──> [T+10 to T+15 Days] ──> [Capital Injected]
     (Total LP               (10% to 25% Call             (Notice Period)          (Units Allotted
    Commitment)               for New Deal)                                          at Par/NAV)

Committed Capital: The total legally binding financial quantum an investor pledges to contribute to the fund during the investment period.
Investable Funds: Committed capital minus estimated lifetime management fees, organizational expenses, operating overhead, and portfolio placement costs.
Drawdown (Capital Call): A formal legal notice issued by the Manager requiring the LP to wire a specified portion of their committed capital (typically 10%–25% per call) within a stipulated notice window (commonly 10 to 15 business days) to fund an approved transaction or fee expense.

Defaulting LP Mechanics and Statutory Remedies

When an LP fails to honor a capital call within the specified notice window and subsequent cure period (usually 15 to 30 days), the LP is declared a Defaulting Investor.

To preserve the fund's liquidity and protect the non-defaulting unit-holders from transaction failure, the fund legal documentation enforces stringent, legally validated remedies:

Default Remedy	Operational Mechanism	Legal Consequence to Defaulting LP
Default Interest Penalty	Accrual of punitive interest (typically 18% to 24% p.a.) on the unpaid call amount from the due date until full payment.	Financial penalty; must be cleared prior to restoring voting or distribution rights.
Suspension of Rights	Immediate suspension of voting rights, LPAC participation, information rights, and right to participate in future drawdowns.	Complete loss of governance and supervisory voice in fund affairs.
Unit Forfeiture / Haircut	Mandatory cancellation of a predetermined percentage of existing units (commonly 25% to 50% haircut).	Severe permanent loss of accrued equity value.
Forced Secondary Transfer	Compulsory sale of the defaulting LP’s existing units to non-defaulting LPs or third-party secondary buyers at a deep discount (e.g., 50%–70% of prevailing NAV).	Liquidation at distressed pricing; proceeds used to satisfy outstanding call liabilities.
Withholding Distributions	Absolute freeze on all distributions (dividends, capital returns, interest) otherwise payable to the defaulting LP.	Distributions retained by fund and set off against unpaid commitments and penalty interest.

Private Placement Memorandum (PPM) Standardization

The Private Placement Memorandum (PPM) serves as the primary legal disclosure document provided to prospective investors detailing the fund's investment thesis, structure, terms, fees, risks, and governance framework.

Historically, divergent disclosure standards led SEBI in 2020 to introduce a Standardized PPM Template across all AIF categories, comprising two mandatory sections:

Part A: Standardized core disclosures structured uniformly across all funds (investment strategy, team qualifications, risk factors, fees, operating expenses caps, conflict-of-interest policies, distribution waterfall mechanics).
Part B: Fund-specific supplementary information, proprietary transaction sourcing methodologies, and track records.

PPM Regulatory Governance Loop:
┌─────────────────────────┐      Annual Audit      ┌─────────────────────────┐
│ Standardized PPM Part A ├───────────────────────>│ Independent Audit Firm  │
│ (Core Statutory Terms)  │                        │ (CA or Company Sec.)    │
└─────────────────────────┘                        └───────────┬─────────────┘
             ▲                                                 │
             │              Annual Findings Filed              ▼
             └─────────────────────────────────────── [SEBI & Trustee Board]

Annual PPM Audit Requirement

SEBI mandates that every AIF conduct an Annual Compliance Audit of its PPM terms by an independent chartered accountant or company secretary. The auditor evaluates:

Whether investments complied strictly with the stated investment strategy and concentration caps.
Whether actual fees, expenses, and transaction costs charged to the fund remained within the exact caps disclosed in the PPM.
Whether conflict-of-interest transactions were escalated to the Trustee / LPAC in accordance with stated covenants. The audit report must be placed before the Trustee, Board of the Manager, and filed with SEBI within 6 months from the end of the financial year.

Cyber Security and Cyber Resilience Framework (CSCRF 2024)

In August 2024, SEBI notified the unified Cyber Security and Cyber Resilience Framework (CSCRF) applicable to all qualified REs (Regulated Entities), including AIF Managers:

Mandatory appointment of a designated Chief Information Security Officer (CISO).
Establishing air-gapped data retention, immutable audit trails, and multi-factor authentication (MFA) across all investor portals and fund administration databases.
Mandatory bi-annual cyber audits and periodic vulnerability assessments and penetration testing (VAPT).
Incident reporting obligation requiring cyber breaches to be formally reported to SEBI and CERT-In within 6 hours of detection.

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