Chapter 15: Regulatory Framework of Alternative Investment Funds (AIFs) — Comprehensive Short Notes (Part 1 of 5)
15.1 Registration Process and Eligibility Criteria of Alternative Investment Funds (AIFs)
15.1.1 Overview and Legal Definition of AIFs
An Alternative Investment Fund (AIF) means any fund established or incorporated in India which is a privately pooled investment vehicle that collects funds from sophisticated investors, whether Indian or foreign, for investing them in accordance with a defined investment policy for the benefit of its investors. AIFs play a vital role in providing risk capital to early-stage ventures, social ventures, SMEs, infrastructure, and other sectors that the government and regulators consider as socially or economically desirable.
15.1.2 Permissible Legal Structures for Establishing an AIF
Under the SEBI (Alternative Investment Funds) Regulations, 2012, an applicant can choose from four distinct legal structures to form and register an AIF:
- Trust: Established under the Indian Trusts Act, 1882, and registered under the Registration Act, 1908. This is historically and currently the most popular structure for constituting an AIF in India.
- Limited Liability Partnership (LLP): Incorporated under the provisions of the Limited Liability Partnership Act, 2008.
- Company: Registered under the Companies Act, 2013 (or any previous Central or State Act).
- Body Corporate: Established or set up under the laws of the Central or State Legislature.
15.1.3 Registration Eligibility Criteria and Key Documentation
SEBI determines the eligibility of an applicant to be registered as an AIF through a rigorous examination of the constitutional documents, credentials of the key personnel, and structural characteristics. The key evaluation parameters include:
1. Constitutional Compliance and Public Invitation Ban
- The constitutional documents (Memorandum of Association for Companies; Trust Deed for Trusts; Partnership Deed for LLPs) must explicitly permit the undertaking of AIF activities.
- Prohibition of Public Solicitation: All AIF applicants are strictly prohibited from making an invitation to the public to subscribe to their units. Accordingly, a specific clause prohibiting public invitations must be formally incorporated in the constitutional document of the applicant.
2. "Fit and Proper Person" Standards
The Applicant, including its Sponsor and Manager, must satisfy the requirements of being a "fit and proper person" based on the criteria specified in Schedule II of the SEBI (Intermediaries) Regulations, 2008. These criteria evaluate:
- Integrity, Reputation, and Character: Assessing the track record and reputation of the entity and its promoters.
- No Enforcement History: No history of restraint orders, suspensions, or convictions by any court or regulatory authority.
- Financial Competence: Evaluating the overall net worth and solvency of the Sponsor and Manager.
- No Defaulter History: Confirming that none of the connected entities or key persons have been declared as a willful defaulter.
3. Key Investment Team Qualifications and Certifications
The key investment team of the Manager of the Alternative Investment Fund must fulfill the following mandatory criteria:
- Relevant Certification: At least one key personnel must possess the relevant professional certification as specified by SEBI. (e.g., the NISM-Series-XIX-C: Alternative Investment Fund Managers Certification Examination or other specified equivalents).
- Professional Qualification: At least one key personnel must possess a professional qualification in finance, accountancy, business management, commerce, economics, capital market, or banking from a university or institution recognised by the Central or State Government, or a foreign university, or possess a CFA charter from the CFA Institute.
- Integration of Requirements: Both the certification and professional qualification requirements can be fulfilled by the same key personnel.
4. Infrastructure, Objective, and Refusal Checks
- Adequate Infrastructure: The Manager or Sponsor must have the necessary physical and digital infrastructure, technology, and manpower to effectively discharge their duties and activities.
- Clear Structure Definition: The applicant must clearly describe, at the time of registration, the investment objective, target investors, proposed corpus, investment style/strategy, and the proposed tenure of the fund or scheme.
- No Prior Refusals: SEBI verifies whether the applicant or any entity established by the Sponsor or Manager has previously been refused a registration certificate by SEBI or had its registration suspended.
15.1.4 Comprehensive Disclosure Requirements for AIF Applicants
An AIF applicant must submit all necessary structural, commercial, and financial information to SEBI in a prescribed format (such as Form A) at the time of seeking registration.
The detailed breakdown of mandatory disclosure particulars includes:
| Category of Disclosures | Specific Disclosure Particulars Required in Application |
|---|---|
| General Information | • Contact details of the registered office and principal place of business.• Direct contact numbers and email ID of the designated contact person.• Legal structure of the applicant (Company, LLP, Trust, or Body Corporate) with date and place of incorporation.• Target Category under which registration is sought (Category I, II, or III).• Fund structure (whether open-ended or closed-ended).• Fund infrastructure to conduct alternative investment activities.• Draft copy of the Private Placement Memorandum (PPM).• Details of any previous registration of the applicant with SEBI, RBI, or any other regulatory authority. |
| Applicant Details:Trust Structure | • Comprehensive details of proposed trust activities.• Verification of whether the Trust Deed is registered under the Registration Act, 1908.• Verification of whether the Trust Deed permits activities of an AIF and contains the public invitation ban.• Trustee Details: Contact details of the registered office, direct contact numbers and email ID of the contact person, identity and address proofs of trustees/directors of the trustee company, brief write-up/profile of the trustees, and past registrations with SEBI/RBI. |
| Applicant Details:Company/Body Corporate Structure | • Comprehensive details of company activities.• Complete shareholding pattern and profiles of directors.• For Bodies Corporate: verification if set up under Central or State Legislature.• Verification of whether the Memorandum of Association (MoA) permits AIF activities and whether MoA and Articles of Association (AoA) prohibit public invitations. |
| Applicant Details:LLP Structure | • Comprehensive details of LLP activities.• Detailed beneficial ownership pattern and profiles of the partners.• Verification of whether the Partnership Deed is duly filed under the Limited Liability Partnership Act, 2008 and permits AIF activities.• Verification of whether the partnership deed prohibits public invitations to subscribe. |
| Sponsor Details | • Contact details, principal place of business, and legal structure (with incorporation date).• Individual Sponsor: Details of professional qualifications and a brief profile.• Non-Individual Sponsor: Detailed shareholding pattern or partnership interests, professional qualifications and profiles of directors/partners.• Identity and address proofs of Sponsor, its Directors, or Partners.• Details of past registration with SEBI, and past experience in managing capital pools, fund management, asset management, investment advisory, or dealing in securities and financial assets.• Copies of audited financial statements for the previous financial year.• Details of any past AIFs or Venture Capital Funds (VCFs) registered with SEBI and floated by the Sponsor. |
| Investment Manager Details | • Registered office contact details, principal place of business, legal structure, and date of incorporation.• Professional qualifications and profiles of the Investment Manager (or directors/partners in case of non-individuals).• Shareholding pattern or partnership interests in the management entity.• Identity and address proofs of the Investment Manager, its directors, or partners.• SEBI registration history and past experience in fund/asset management, investment advisory, and securities market dealings.• Audited financial statements for the previous financial year.• Details of any AIF or VCF previously managed or advised by the Investment Manager. |
| Business Plan and Strategy | • Investment objective, style, and strategy of the fund.• Target investors, target sectors, and proposed corpus of the fund.• Proposed fees and commercial payouts to the Sponsor and Manager.• Tenure of the fund or scheme.• Detailed proposed use of leverage, if applicable. |
| Disciplinary & Regulatory History | • Details of any past or ongoing litigation in the securities market and any orders passed against the Applicant, Sponsor, or Investment Manager for violation of securities laws.• Litigation details having an adverse effect on the applicant's business.• Details of any prior registration refusals or suspensions by SEBI. |
| Fit & Proper Declaration | • Signed declaration from the Applicant, Sponsor, and Manager stating that they satisfy the "fit and proper" person criteria as specified by SEBI. |
15.1.5 General Conditions of Registration
Upon being granted a certificate of registration by SEBI, the Alternative Investment Fund must abide by the following ongoing conditions:
- Compliance with Regulations: The AIF must strictly abide by the provisions of the SEBI Act, 1992 and the SEBI (Alternative Investment Funds) Regulations, 2012.
- Exclusivity of Activity: The AIF shall not carry on any other business or activity other than those permitted under the regulations.
- Duty to Inform of Material Changes: The AIF must forthwith inform SEBI in writing if any information or particulars previously submitted are found to be false or misleading in any material aspect, or if there is any material change in the information already submitted.
15.1.6 The SEBI "In-Principle" Approval Mechanism
Recognising that setting up trusts, registering deeds, or incorporating LLPs can be time-consuming, SEBI offers an In-Principle Approval route to expedite the setup process:
- If SEBI is satisfied that the applicant meets the registration eligibility criteria, it may grant an "in-principle" approval even if the Trust Deed or Partnership Deed is not yet registered under applicable law.
- Timeline for Registration: Following the in-principle approval, the applicant must ensure that the Trust Deed or Partnership Deed is duly registered under the applicable law within 6 months from the date of the in-principle approval.
- Strict Capital Collection Ban: Under the in-principle approval, the applicant is permitted to approach investors to raise capital commitments, but it shall not call or accept money from those investors until it receives the final Registration Certificate from SEBI.
15.2 Sponsor and Manager Commitment ("Skin in the Game")
To align the interests of the Sponsors and Managers with the investors of the AIF, SEBI mandates a compulsory investment commitment, commonly referred to as "skin in the game".
15.2.1 Mandatory Sponsoring Commitment Levels
The Sponsor or Manager of a Category III AIF must maintain a continuing interest in the fund of not less than:
- 5 percent of the corpus of the fund, OR
- INR 10 crore, whichever is lower.
(Note: For Category I and Category II AIFs, the standard Sponsor commitment is 2.5 percent of the corpus or INR 5 crore, whichever is lower).
15.2.2 Key Conditions of the Sponsor/Manager Commitment
- No Fee Waivers: The sponsoring commitment must be in the form of actual, tangible investment in the scheme of the fund; it shall not be achieved through the waiver of management fees.
- Discretionary Employee Participation: If employees or directors of the fund, or employees or directors of the investment manager, choose to participate as investors in the fund in their individual capacity, their contribution shall not be less than INR 25 lakh.
- Mandatory Disclosure: The Manager and Sponsor must transparently disclose their investment interest and holding in the AIF to all the investors.
- Fiduciary Duty: The Sponsor and Manager retain a strict fiduciary duty towards the investors and must disclose all potential and actual conflicts of interest.
15.3 Concept of Open-ended and Close-ended Funds
A scheme of a Category III Alternative Investment Fund may be structured either as an open-ended fund or a close-ended fund at the time of registration.
15.3.1 Key Structural Differences
| Parameter of Comparison | Open-ended Fund Structure | Close-ended Fund Structure |
|---|---|---|
| Admission & Contribution | • Investors contribute capital upon admission or subscription to the fund.• Investors may make additional capital contributions from time-to-time as permitted. | • Investors make capital commitments, which are subsequently called by the Manager.• Capital calls are made over a pre-defined period known as the "Commitment Period". |
| Commitment Period | • Not applicable; contributions are transaction-based or periodic. | • The Commitment Period is usually the first three years of the Fund Tenure. |
| Redemption of Capital | • Permitted at pre-defined regular intervals, which can be quarterly, half-yearly, or yearly. | • Redemption of capital is strictly not permitted prior to the winding-up of the fund or scheme.• Early exits from the scheme may attract a pre-defined exit load as specified in the PPM. |
| Tenure | • Infinite/Flexible or as defined by the scheme documents. | • Fixed tenure (e.g., 3 or 5 years). Tenure commences from the date of the "First Close". |
15.3.2 Listing of Close-ended Funds and Schemes
Units of a scheme launched by a close-ended Category III AIF are eligible to be listed on a recognised stock exchange. Listing of units is subject to the following regulatory conditions:
- Voluntary Nature: The listing of close-ended funds or schemes on a recognised stock exchange is entirely voluntary.
- Timing of Listing: Listing of units is permitted only after the final close of the fund or scheme has been achieved.
- Minimum Tradable Lot: The close-ended scheme must have a minimum tradable lot of INR 1 crore.
- Angel Fund Exception: Units of angel funds are strictly prohibited from being listed on any recognised stock exchange.
The Formal Listing Process (Step-by-Step)
- Listing Application: The AIF must submit a formal application to a recognised stock exchange for listing the units of its close-ended scheme, submit all required documentation, and pay the designated fees based on the size of the scheme.
- In-Principle Exchange Approval: Based on the submitted documentation, the recognised stock exchange grants an in-principle approval for listing the scheme units on its trading platform.
- SEBI Listing Approval: The AIF seeks formal approval from SEBI for the listing of the close-ended scheme units.
- Final Listing: After receiving the regulatory approvals, the recognised stock exchange grants the final approval and lists the units of the close-ended scheme for trading.
Core Strategic Benefits of Listing AIF Units
- Easy Exit Opportunity: It provides investors with a structured, transparent, and compliant exit route, subject to standard KYC norms.
- Price Discovery: Listing enables market-driven price discovery through demand-supply dynamics on the exchange platform.
- NAV Transparency: It allows investors to view and track the Net Asset Value (NAV) of the fund on a timely and regular basis.
- Liquidity: It infuses overall liquidity into the illiquid alternative investment ecosystem.
15.4 Key Exam-Relevant Terms and Definitions
- Alternative Investment Fund (AIF): A privately pooled investment vehicle established in India to collect funds from sophisticated Indian or foreign investors for investment under a defined policy.
- Fit and Proper Person: A regulatory benchmark assessing the integrity, character, financial competence, solvency, and lack of adverse regulatory history of AIF intermediaries, Sponsors, and Managers.
- In-Principle Approval: A preliminary approval granted by SEBI allowing an AIF applicant to market and raise commitments for 6 months before registering the formal Trust/Partnership deed, during which actual capital inflows are prohibited.
- Sponsor Commitment: The mandatory minimum financial stake ("skin in the game") that a Sponsor/Manager must hold in the scheme of the Category III AIF, equal to 5% of the corpus or INR 10 crore, whichever is lower.
- Commitment Period: The initial phase of a close-ended fund (usually the first 3 years of the tenure) during which the Investment Manager makes capital calls to draw down committed capital from investors.
15.5 Key Takeaways for Alternative Investment Managers
- Structuring Priority: While Companies and LLPs are available options, the Determinate Trust remains the preferred vehicle for Indian domestic AIF setups because it offers greater operational flexibility and structured tax pass-through benefits.
- Certification & Manpower Alignment: Investment Managers must ensure that their key personnel satisfy the dual-requirement of professional academic qualifications (e.g., CFA, Business Management degree) and regulatory certifications (NISM AIF series) to avoid application rejections.
- Strict Public Invitation Boundary: An AIF cannot behave like a mutual fund or public issue. High net-worth individual (HNI) and institutional fundraising must remain strictly a private placement affair.
- Commitment Restrictions: Managers cannot fund their Sponsor Commitment through deferred management fees. Actual cash capital must be deployed, ensuring true financial alignment with the unit holders.