CHAPTER 4 (PART 2): AIF REGULATORY FRAMEWORK

Accredited Investors, Raising of Corpus, Placement Memorandum, and General Investment Conditions

1. Introduction to the AI Framework and Capital Raising

The SEBI regulatory framework incorporates specialised entry channels and operating flexibilities to cater to different classes of investors. By distinguishing between standard retail/HNI investors and highly sophisticated Accredited Investors (AIs), SEBI provides significant concessions and exemptions from standard requirements. Similarly, the process of raising corpus capital and the investment conditions applicable to all Alternative Investment Funds (AIFs) are designed to maintain institutional-grade discipline, diversification, and market integrity.

2. 4.1.7 Accredited Investor, Accreditation Agencies, and the AI Framework

SEBI introduced the Accredited Investor (AI) framework to provide sophisticated market participants with enhanced flexibility in their investment amounts and key concessions from specific regulatory compliance burdens.

A. Definition of Accredited Investors

An Accredited Investor is any person (domestic or foreign) who holds a valid certificate of accreditation from an approved Accreditation Agency, based on meeting the following strict financial eligibility criteria:

Audit & Verification Rule: For Body Corporates and Trusts, financial eligibility is evaluated using either:

1. Financial information as per the statutory audit, or
2. Financial information as per an audit conducted by a statutory auditor, as on a date during the financial year in which the accreditation application is made.

B. Deemed Accredited Investors

Certain high-profile institutions are considered "deemed" Accredited Investors and do not require a separate application or certificate from an accreditation agency:

• Central Government and State Governments.
• Developmental agencies set up under the aegis of the Central or State Governments.
• Funds set up by the Central Government or State Governments.
• Qualified Institutional Buyers (QIBs) as defined under the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2018.
• Category I Foreign Portfolio Investors (FPIs).
• Sovereign Wealth Funds and multilateral agencies.
• Any other entity specified by SEBI from time to time.

C. The Accreditation Process

• Accreditation Agencies: These are designated subsidiaries of recognized stock exchanges, subsidiaries of depositories, or other entities specified by SEBI. They must possess the necessary systems, physical infrastructure, and manpower to execute their duties.
• Fit & Proper Verification: Applicants seeking accreditation must apply to these agencies and satisfy "fit and proper" person requirements. They must not be willful defaulters, have outstanding regulatory convictions, or be subject to active restraint orders in the securities market.

3. 4.1.8 Raising of Corpus Capital and the Private Placement Memorandum (PPM)

AIFs are strictly private investment vehicles, meaning they are barred from accessing retail public markets.

A. Corpus Raising Regulations

1. Strict Private Placement Ban on Public Solicitations: An AIF cannot solicit or collect funds for corpus creation except through the private placement of units. Public NFOs (New Fund Offers) are strictly illegal for AIFs.
2. Minimum Corpus Size: Every scheme launched by an AIF must maintain a minimum corpus of INR 20 crore.
3. Investor Cap: No scheme of an AIF shall have more than 1000 investors. (For corporate-structured AIFs, this limit is governed by the Companies Act, 2013).
4. Minimum Contribution Thresholds:
   • Standard Investors: The minimum investment contribution from a single investor in an AIF or its scheme is INR 1 crore.
   • Employees & Directors: For employees or directors of the AIF, or employees or directors of its Investment Manager, the minimum contribution is lowered to INR 25 lakh.
   • Accredited Investor Exemption: These minimum contribution limits (INR 1 crore and INR 25 lakh) do not apply to Accredited Investors.
5. Joint Investing Rules: Joint investment in an AIF can only be made by an investor with their spouse, parent, or child. No more than 2 persons can act as joint investors under this concession. If any other combination of joint investors applies, the standard minimum contribution of INR 1 crore applies to each investor individually.
6. Stock Exchange Listing: Close-ended AIF schemes can list their units on a stock exchange to provide liquidity. However, listing is permitted only after the final close of the scheme, and units must be traded in a minimum lot size of INR 1 crore.

B. Private Placement Memorandum (PPM) Disclosures

The PPM is the key constitutional disclosure document that an AIF must issue to prospective investors. It must contain exhaustive disclosures on the following:

• Complete details on the Sponsor, Manager, Trustee, Custodian, and Merchant Banker.
• Stated investment strategy, target investors, and proposed corpus size (including any green-shoe option).
• Fees and expenses proposed to be charged to the fund or investee companies.
• The tenure of the scheme and any conditions/limits on unit redemption.
• Terms of reference for the committee constituted for approving investment decisions (the Investment Committee).
• Procedures to identify and address conflicts of interest.
• Comprehensive risk management tools and risk parameters.
• Disciplinary history of the Sponsor, Manager, Trustee, and their associates.
• Detailed processes for winding up and liquidating the AIF scheme.

C. SEBI Filing and PPM Audit Requirements

• Merchant Banker Route: The AIF Manager must file the draft PPM with SEBI through a registered merchant banker at least thirty (30) days prior to the proposed launch of the scheme, along with specified fees. SEBI’s comments must be fully incorporated into the PPM before launch.
• Exemption for LVFs: Large Value Funds (LVFs) for Accredited Investors (where each investor contributes at least INR 70 crore) are completely exempt from filing draft PPMs with SEBI and from the SEBI comment process. They can launch schemes directly.
• PPM Compliance Audit: AIFs must carry out an annual audit of compliance with PPM terms at the end of each financial year. This audit is conducted by an internal or external auditor or legal professional. Audit findings and corrective steps must be submitted to the Trustee, Board of the Manager, and SEBI within 6 months of the end of the financial year.
• Audit Exemptions: The annual PPM audit is not applicable to:
  1. Angel Funds.
  2. AIF schemes in which each investor commits a minimum capital contribution of INR 70 crore (or USD 10 million/equivalent) and signs a formal waiver exempting the fund from this requirement.

4. 4.1.9 General Investment Conditions for All AIF Categories

Regardless of whether they are Category I or Category II, all AIFs must adhere to standard investment restrictions to manage concentration, related-party risks, and leverage.

A. Diversification and Concentration Limits

• Standard Category I & II AIFs: Standard schemes are strictly prohibited from investing more than 25% of their investable funds in a single investee company, whether directly or through units of other AIFs.
• Large Value Funds (LVFs): Schemes classified as Large Value Funds for Accredited Investors are permitted to invest up to 50% of their investable funds in a single investee company, directly or through units of other AIFs.

Essential Definition — Investable Funds: This refers to the total corpus of the AIF scheme net of estimated administration and management expenses for the entire tenure of the fund.

B. Related-Party and Associate Restraints

• No Related-Party Investments Without Consent: An AIF cannot invest in its associates or in the units of other AIFs managed/sponsored by its Manager, Sponsor, or their associates, except with the prior approval of at least 75% of investors by value of their investment in the AIF.
• Secondary Transactions with Associates: Any buy or sell of investments from or to associates (or other schemes managed/sponsored by the Manager or Sponsor) requires the prior approval of 75% of the investors by value.
• Conflict of Interest Voting Exclusion: If an AIF scheme conducts a secondary buy/sell transaction with an investor who has committed at least 50% of the corpus of the scheme, that specific investor must be excluded from voting on the transaction approval.

C. Un-invested Funds and Cash Management

Pending deployment of funds into target investee companies, or pending distribution of exit proceeds to investors, AIFs can temporarily house their un-invested cash in highly liquid, safe assets:

1. Liquid mutual funds.
2. Bank deposits.
3. High-quality liquid assets such as Treasury Bills, Triparty Repo (TREPS), Commercial Papers (CPs), and Certificates of Deposit (CDs).

D. Platform Listing and Dematerialisation Rules

• Nominated Investor Status: AIFs are permitted to act as a Nominated Investor under SEBI ICDR Regulations to subscribe to the unsubscribed portions of public issues made by SME companies.
• Listed SME Shares Deemed "Unlisted": Any investment made by a Category I or Category II AIF in shares of entities listed on an institutional trading platform (SME segment) is legally deemed to be an investment in unlisted securities for regulatory compliance.
• Mandatory Dematerialisation: AIFs are required to hold all of their investments in dematerialised form. The only exceptions are:
  1. Investments in assets or instruments that are not legally eligible for dematerialisation.
  2. Investments held by an active AIF liquidation scheme that are not available in dematerialised form.
  3. Other specific exceptions as notified by SEBI.
• Strict Category III Rule: All investments made by Category III AIFs on or after July 01, 2025 must be held in dematerialised form only, regardless of whether they are directly subscribed to or acquired secondarily.

Important Terms & Exam Definitions

1. Accredited Investor (AI): An investor certified by an approved agency as having the financial capacity to bear alternative asset risks, thus gaining minimum investment concessions.
2. Deemed Accredited Investor: High-profile institutional investors (e.g., Governments, QIBs, SWFs) automatically granted AI status without certification.
3. Investable Funds: The net corpus of an AIF scheme after deducting estimated administrative and management fees for the entire tenure of the scheme.
4. Large Value Fund (LVF): A specialized scheme where every investor contributes at least INR 70 crore, allowing up to 50% investable funds concentration and exemption from PPM filing/audit rules.
5. Nominated Investor: An AIF role that permits direct subscription to unsubscribed SME public issue portions to support listing.