CHAPTER 4 (PART 1): AIF REGULATORY FRAMEWORK

SEBI (Alternative Investment Funds) Regulations, 2012 — Registration, Commitments, Co-Investments, and Tenure

1. Introduction to the SEBI AIF Regulations

The SEBI (Alternative Investment Funds) Regulations, 2012 (commonly referred to as the AIF Regulations) are the primary guidelines regulating AIF operations in India. Prior to these regulations, legacy structures like Venture Capital Funds operated under older, separate frameworks. Today, these regulations ensure that private capital pools are securely, uniformly, and transparently managed to safeguard investor interest.

2. 4.1.1 Registration Requirements

All Alternative Investment Funds (AIFs) domiciled in India—meaning those established or incorporated in the country—must undergo compulsory registration with SEBI before conducting any operational or fund-raising activity.

• Bans on Legacy Monies: Any active fund or scheme that existed prior to the initiation of these regulations is permitted to complete its designated tenure but is strictly prohibited from raising any fresh capital. They are only allowed to call down capital from commitments that were legally locked in prior to the date of their registration application.
• Transition of Legacy VCFs: Legacy Venture Capital Funds registered under the erstwhile SEBI (Venture Capital Funds) Regulations, 1996 continue to operate under those rules until they are wound up.
• Re-registration Protocol: Legacy funds can choose to migrate to the modern SEBI (AIF) Regulations, 2012, provided they secure the prior consent of at least two-thirds (2/3rds) of their investors by value of their total investments.
• Registration Categories: Applicants must seek registration under specific categories according to their core strategy:
  1. Category I AIF: Invests in start-ups, early-stage ventures, social ventures, SMEs, infrastructure, or other economically/socially desirable sectors. It includes venture capital, SME, social impact, special situation, infrastructure, and Corporate Debt Market Development Funds (CDMDF). These funds receive positive government/regulatory incentives or concessions.
  2. Category II AIF: Includes funds like Private Equity (PE) or Debt Funds that do not fall under Category I or III and do not use leverage or borrowing except for day-to-day operations. No specific government incentives or concessions are given to this category.
  3. Category III AIF: Employs complex or diverse trading strategies (like hedge funds) and may use leverage, including listed/unlisted derivative trading.

3. 4.1.2 Registration Criteria and Documentation

To register an AIF, the Sponsor or Manager must submit Form A to SEBI along with a non-refundable application fee. SEBI evaluates the application based on the following documents and eligibility criteria:

A. Permitted Constitutional Structures

An AIF can be established in three distinct ways, and its charter documents must explicitly authorize alternative investment activities:

1. Trust Structure: Governed by an irrevocable Trust Deed registered under both the Indian Trusts Act, 1882 and the Registration Act, 1908.
2. Limited Liability Partnership (LLP) Structure: Governed by a Partnership Deed registered under the Limited Liability Partnership Act, 2008.
3. Company Structure: Governed by a Memorandum of Association (MoA) registered under the Companies Act, 2013.

Crucial Exam Rule: The constitutional charter document (Trust Deed, MoA, or LLP Agreement) must contain a strict, explicit clause prohibiting any public invitation to subscribe to its units or securities. Fund-raising is permitted strictly through private placement.

B. "Fit and Proper Person" Standards

The applicant, Sponsor, and Manager must continuously satisfy the "fit and proper" criteria detailed in Schedule II of the SEBI (Intermediaries) Regulations, 2008. This evaluates integrity, honesty, ethical conduct, reputation, and the absence of key legal disqualifications (such as pending criminal charges, insolvency, active debarment, or being declared a willful defaulter).

C. Key Investment Team Competence

The Investment Manager’s key investment team must satisfy strict competency standards:

• NISM Certification: At least one key personnel must have passed the NISM-Series-XIX-C: Alternative Investment Fund Managers Certification Examination. If the certification expires, they must obtain a fresh certification to maintain compliance.
• Professional Qualification: At least one key personnel must hold a professional qualification in finance, accountancy, business management, commerce, economics, capital markets, or banking, or hold a CFA Charter from the CFA Institute.
• Dual-Fulfillment Rule: Both of the above requirements—the NISM certificate and the professional degree/CFA Charter—must be fulfilled by the same key personnel.

D. Operational and Strategy Disclosures

• Manpower and Infrastructure: The Sponsor or Manager must have the necessary physical infrastructure and team to discharge its duties.
• Filing Clarity: The fund must clearly define and document its investment objective, target investors, proposed corpus, investment style/strategy, and proposed tenure at the time of registration.
• Clean History: SEBI will verify whether the applicant, or any entity established by its Sponsor or Manager, has previously been refused a registration certificate by SEBI.

4. 4.1.3 Conditions for Registration

An AIF must abide by several ongoing operational conditions to keep its registration certificate active:

1. The AIF must strictly comply with the SEBI Act, 1992, the AIF Regulations, 2012, and all subsequent SEBI circulars.
2. The AIF must not carry out any business or operations outside of permitted activities.
3. The AIF must immediately inform SEBI in writing if any information or details previously filed are discovered to be false or misleading, or if there is any subsequent material change in those details.
4. An AIF cannot change its registered category (e.g., from Category I to Category II) post-registration without prior written approval from SEBI.

5. 4.1.4 Sponsor / Manager Commitment (Continuing Interest)

To establish proper alignment of interests and "skin-in-the-game," the Sponsor or Investment Manager must maintain a continuous financial investment (continuing interest) in each scheme of the AIF.

Minimum Commitment Thresholds (Category I and II AIFs)

• At least 2.5% of the corpus of the scheme, or
• INR 5 crore, whichever is lower.

Key Rules Governing Sponsor Commitment

• No Fee-Waiver Substitution: This commitment must be met through an actual cash investment in the capital of the AIF. It cannot be substituted by waving or adjusting management fees that the manager proposes to earn.
• Disclosures: The Manager/Sponsor must fully disclose their exact investment interest in the scheme to all investors.
• Individual Employee/Director Participation: If individual employees or directors of the AIF or its Investment Manager choose to invest in the fund in their personal capacities, their minimum investment threshold is lowered to INR 25 lakh (compared to the standard investor minimum of INR 1 crore).

6. 4.1.5 Co-investments

Co-investment is an investment made by the Manager, Sponsor, or an existing investor of a Category I or II AIF directly in an investee company where the AIF itself makes an investment.

Strict SEBI Rules for Co-investments (Post-December 8, 2021)

• Portfolio Manager Route: Co-investment by investors of Category I and II AIFs can only be made through a registered Co-investment Portfolio Manager under the SEBI (Portfolio Managers) Regulations, 2020.
• No Favorable Treatment: The terms of the co-investment (by the Sponsor, Manager, or co-investor) cannot be more favorable than the terms of the investment made by the AIF.
• Identical Exit Timing: The exit from the co-investment—including the exact timing of the exit—must be identical to that of the AIF's exit from the investee company.
• Advisory Restraints: The Investment Manager is strictly prohibited from providing separate investment advisory services to any investor, other than clients of the Co-investment Portfolio Manager, for the investee companies of the AIF.

7. 4.1.6 Tenure of Fund and Schemes

Since alternative assets are highly illiquid, Category I and Category II AIFs must be set up as close-ended vehicles.

Tenure Rules and Extensions

• Minimum Term: Every scheme launched under Category I and II AIFs must have a minimum tenure of three (3) years.
• Start Date: The tenure begins on the date of the first close of the scheme and ends on the last date specified in the fund documents.
• General Extension Limit: Schemes can extend their close-ended term by up to two (2) years.
• Investor Approval Rule: Any such extension requires the prior formal approval of at least two-thirds (2/3rds) of the unit holders by value of their total investment in the AIF.
• Large Value Funds (LVFs) Exception: Schemes classified as Large Value Funds for Accredited Investors (where each investor contributes a minimum of INR 70 crore) can extend their tenure by up to five (5) years, subject to the same two-thirds (2/3rds) investor approval by value.
• Mandatory Liquidation on Non-Extension: If the scheme fails to secure the required 2/3rds approval for an extension, or when the extended tenure expires, the scheme must be fully wound up and fully liquidated within one (1) year.

Important Terms & Exam Definitions

1. Compulsory Registration: The legal requirement stating no domestic pooling fund can operate as an AIF without SEBI’s registration certificate.
2. Continuing Interest: The mandatory, continuous financial stake (2.5% of corpus or INR 5 crore, whichever is lower) that Category I & II Sponsors must maintain.
3. Co-investment Portfolio Manager: A portfolio manager registered under SEBI (Portfolio Managers) Regulations, 2020, through whom AIF investor co-investments must be routed.
4. Large Value Fund (LVF): An AIF scheme in which every investor is an accredited investor contributing a minimum of INR 70 crore, allowing concessions like up to 5 years of tenure extension.