Chapter 5: Regulatory Framework (Part 1 of 6)
5.1 SEBI (Alternative Investment Funds) Regulations, 2012
The Alternative Investment Fund (AIF) market in India is regulated and monitored by the Securities and Exchange Board of India (SEBI), which is the statutory regulatory body entrusted with the responsibility of regulating Indian capital markets. SEBI’s mandate includes protecting the interests of investors, enforcing rules and regulations, and promoting the orderly development of the securities market.
To establish a structured regulatory regime for privately pooled investment vehicles, SEBI introduced the SEBI (Alternative Investment Funds) Regulations, 2012 (the "AIF Regulations") on May 21, 2012. These regulations repealed the erstwhile SEBI (Venture Capital Funds) Regulations, 1996 and established a unified framework for all types of privately pooled funds operating in India.
5.1.1 Definition of an Alternative Investment Fund (AIF)
Under the SEBI (AIF) Regulations, an AIF is defined as a privately pooled investment vehicle established or incorporated in India.
Legal Structures of AIFs
An AIF can be constituted in India in any of the following permissible legal structures:
- A Trust established under a Trust Deed, which must be duly registered under the provisions of the Registration Act, 1908.
- A Company incorporated under the Companies Act, 2013.
- A Limited Liability Partnership (LLP) incorporated under the Limited Liability Partnership Act, 2008.
- A Body Corporate set up or established under the laws of the Central or State Legislature.
Scope of Private Pooling
The defining characteristic of an AIF is that it pools capital from domestic or offshore investors to invest in accordance with a defined investment policy for the benefit of its investors. However, the legal documents of the applicant entity (such as the Memorandum of Association for companies, Trust Deed for trusts, or Partnership Deed for LLPs) must expressly prohibit making any invitation to the public for the subscription of its securities or units. Funds must be raised strictly through a private placement mechanism.
5.1.2 Categorisation of Alternative Investment Funds
To apply proportional operational and prudential requirements, SEBI divides registered AIFs into three distinct categories based on their investment objectives, target sectors, and the potential impact they have on the broader financial system.
| Category | Broad Classification | General Focus |
|---|---|---|
| Category I | Funds considered beneficial to the economy/society | Venture capital, infrastructure, social impact, etc. |
| Category II | Residual category for funds that do not fall under Category I or III | Private equity, debt, and similar funds |
| Category III | Funds employing diverse or complex trading strategies | Hedge-fund-type strategies, including permitted leverage/trading strategies |
1. Category I AIF
These are funds that invest in start-ups, early-stage ventures, social ventures, Small and Medium Enterprises (SMEs), infrastructure, or other sectors or areas that the government or regulators consider socially or economically desirable. These funds are considered economically beneficial and are often provided specific incentives or concessions by the government or other regulators.
- Sub-categories of Category I AIFs:
- Venture Capital Funds (including Angel Funds)
- SME Funds
- Social Impact Funds
- Infrastructure Funds
- Special Situation Funds
- Corporate Debt Market Development Funds
2. Category II AIF
These are funds that do not fall under Category I or Category III and are prohibited from undertaking leverage or borrowing other than to meet day-to-day operational requirements or as permitted under the regulations. No specific incentives or concessions are provided by the government or regulators to this category.
- Sub-categories of Category II AIFs:
- Private Equity (PE) Funds
- Debt Funds
3. Category III AIF
These are funds that employ diverse or complex trading strategies and may employ leverage, including through investment in listed or unlisted derivatives. Category III AIFs are generally structured to trade with a view to making short-term returns, or they may operate as open-ended funds. Unlike Category I, no specific incentives or concessions are provided to Category III AIFs by the government or any other regulator.
- Sub-categories of Category III AIFs:
- Hedge Funds
- Public Equity / Long-Short Funds
5.1.3 Regulatory Comparison of AIF Categories
| Parameters | Category I AIF | Category II AIF | Category III AIF |
|---|---|---|---|
| Primary Definition | Invests in start-ups, early-stage ventures, social ventures, SMEs, infrastructure, or other sectors considered economically/socially desirable. | All AIFs that do not classify under Category I or Category III. | Employs diverse or complex trading strategies and may employ leverage. |
| Permissible Investment Scope | Focuses primarily on early-stage start-ups, infrastructure projects, and unlisted ventures. | Focuses on later-stage investment opportunities, unlisted securities, and debt. | Explores opportunities in primary and secondary markets through all types of securities, including listed/unlisted derivatives. |
| Leverage and Borrowing Limits | Prohibited from employing leverage except for temporary operational purposes. | Prohibited from employing leverage except for temporary operational purposes. | Permitted to employ leverage, subject to a regulatory cap of 2 times the NAV of the fund. |
| Sponsor Skin-in-the-game | Minimum of 2.5% of the corpus or Rs. 5 crore, whichever is lower. | Minimum of 2.5% of the corpus or Rs. 5 crore, whichever is lower. | Minimum of 5% of the corpus or Rs. 10 crore, whichever is lower. |
| Structure Type | Compulsorily close-ended with a defined tenure. | Compulsorily close-ended with a defined tenure. | Can be structured as either open-ended or close-ended. |
| Tax Status | Category-level tax pass-through status for all income except business income. | Category-level tax pass-through status for all income except business income. | No category-level tax pass-through; taxes are charged at the fund level. |
5.2 Registration of a Category III Alternative Investment Fund
No entity is permitted to operate as an Alternative Investment Fund in India unless it has obtained a compulsory Certificate of Registration from SEBI.
5.2.1 Application Process and Fee Structure
To seek registration as a Category III AIF, an applicant must submit an application to SEBI in the prescribed format, known as Form A.
Filing Channel
The application must be filed with SEBI through a registered Merchant Banker. The Merchant Banker acts as an independent intermediary responsible for conducting due diligence on the disclosures in the Private Placement Memorandum (PPM) and issuing a mandatory due diligence certificate.
Regulatory Fee Structure
The fee structure applicable for the registration of a Category III AIF is as follows:
- Application Fee: A non-refundable fee of Rs. 1,00,000 (Rupees One Lakh) must be paid at the time of submitting the application.
- Registration Fee: Once SEBI grants the approval for registration, a registration fee of Rs. 15,000 (Rupees Fifteen Lakhs) must be paid to obtain the Certificate of Registration.
5.2.2 Eligibility Criteria for Registration
Before granting registration to a Category III AIF applicant, SEBI scrutinises the structure of the applicant, its Sponsor, its Investment Manager, and its key personnel against strict eligibility benchmarks.
1. Permissible Constitutional Structures & Legal Documents
The constitutional documents of the applicant must explicitly authorise it to carry on AIF activities:
- Trust Structure: The Trust Deed must be duly registered under the Registration Act, 1908.
- Company Structure: The Memorandum of Association (MoA) and Articles of Association (AoA) must permit the company to carry on alternative investment activities and comply with the Companies Act, 2013.
- LLP Structure: The LLP Agreement must be incorporated and filed with the Registrar of Companies (RoC) under the Limited Liability Partnership Act, 2008.
- Body Corporate: The entity must be set up under Central or State laws and explicitly permitted to carry on alternative investment activities.
2. Prohibition of Public Invitation
The constitutional documents of the applicant (Trust Deed, MoA, or Partnership Deed) must strictly prohibit making an invitation to the public to subscribe to its units or securities.
3. "Fit and Proper Person" Test
The applicant, its Sponsor, and its Investment Manager must fulfill the "fit and proper person" criteria defined under Schedule II of the SEBI (Intermediaries) Regulations, 2008. This assessment evaluates:
- Integrity, reputation, and character.
- Absence of any historical restraint orders, convictions, or administrative actions by financial regulators.
- Financial competence, net worth, and solvency.
- Absence of being classified as a wilful defaulter.
4. Personnel Qualifications and Competence
The key investment team of the Investment Manager must have the requisite qualifications and experience to manage the fund:
- NISM Certification: At least one key personnel in the key investment team of the Manager must obtain certification from the National Institute of Securities Markets (NISM) by passing the NISM Series-XIX-C: Alternative Investment Fund Managers Certification Examination. If this certification expires, the personnel must obtain a fresh certification to maintain continuous compliance.
- Professional Qualification: At least one key personnel must possess a professional qualification in finance, accountancy, business management, commerce, economics, capital markets, or banking from a university or institution recognised by the Central Government, State Government, or a foreign university, or hold a CFA Charter from the CFA Institute.
- Note: Both requirements (NISM Certification and Professional Qualification) can be fulfilled by the same key personnel.
5. Infrastructure and Manpower
The Investment Manager or Sponsor must demonstrate that they have the necessary manpower, office infrastructure, systems, and controls to perform the activities of a Category III AIF effectively.
6. Investment Objectives and Disclosures
The applicant must clearly define and state its investment objectives, targeted class of investors, proposed fund corpus, investment style, investment strategy, and proposed tenure of the fund at the time of application.
7. Disciplinary History
The applicant must disclose any previous history of registration refusal by SEBI, suspension of certificates, or pending regulatory actions against the applicant, Sponsor, Investment Manager, or Trustees.
5.2.3 Comprehensive Disclosure Requirements (Form A)
During the registration process, the applicant must submit a detailed disclosure package to SEBI. The table below lists the essential disclosure particulars required for each constituent of the AIF under Form A:
| No. | Disclosure Area | Key Information Required |
|---|---|---|
| 1 | General Information & Legal Structure | Basic AIF details, constitution and proposed legal structure |
| 2 | Structure-Specific Details | Details relating to the Trust / Company / LLP, as applicable |
| 3 | Sponsor Details | Sponsor's qualifications, experience and net worth |
| 4 | Investment Manager Details | Manager's experience, track record and financial information |
| 5 | Business Plan & Investment Style | Proposed business plan, investment strategy and style |
| 6 | Regulatory Actions & History | Details of regulatory proceedings, actions and relevant history |
| 7 | Compulsory Declaration | Required declarations and confirmations by the applicant |
Detailed Disclosure Particulars under Form A
| Disclosure Category | Particulars Required to be Disclosed |
|---|---|
| General Information | * Contact details of the Registered Office and principal place of business.* Name, direct telephone numbers, and email address of the designated Contact Person.* Legal structure of the applicant (Trust, LLP, Company, or Body Corporate) with the date and place of incorporation.* The target category under which registration is sought (Category III).* Fund structure (Open-ended or Close-ended).* Details of the proposed fund infrastructure.* Draft copy of the Private Placement Memorandum (PPM).* Details of any previous registration with SEBI, RBI, or any other regulator. |
| Applicant Details: Trust | * Details of trust activities.* Proof of Trust Deed registration under the Registration Act, 1908.* Confirmation that the Trust Deed permits AIF activities under Category III.* Absolute prohibition clause in the Trust Deed preventing public invitations to subscribe to units.* Contact details of the registered office of the Trustee Company or individual Trustees.* Name, direct phone numbers, and email address of the Trustee's contact person.* Identity and Address Proof of all Trustees or Directors of the Trustee Company.* Regulatory registration history of the Trustee with SEBI/RBI.* Brief profile and write-up on the activities of the Trustee Company. |
| Applicant Details: Company / Body Corporate | * Details of corporate activities.* Detailed shareholding pattern of the company.* Profiles, professional qualifications, and backgrounds of all Directors.* For a Body Corporate, proof of establishment under Central or State Legislature laws.* Confirmation that the Memorandum of Association (MoA) permits Category III AIF activities.* Proof of prohibition clause in the MoA and AoA preventing public invitation for subscription. |
| Applicant Details: LLP | * Details of LLP activities.* Beneficial ownership pattern of the LLP.* Profiles and professional backgrounds of all partners.* Proof that the Partnership Deed is registered and filed under the Limited Liability Partnership Act, 2008.* Confirmation that the registered partnership deed permits Category III AIF activities and prohibits public invitations to subscribe to its units. |
| Sponsor Details | * Contact details of the Sponsor's registered office and principal place of business.* Name, direct phone number, and email of the Sponsor's contact person.* Legal structure of the Sponsor (Individual, Partnership, Company, or Body Corporate) and date of incorporation.* Individual Sponsor: Brief profile, professional qualifications, and net worth details.* Non-Individual Sponsor: Shareholding pattern, partnership interest details, and profiles of all Directors/Partners.* Identity and Address Proof of the Sponsor and its Directors/Partners.* Details of any past registration of the Sponsor with SEBI.* Sponsor's track record and experience in managing capital pools, fund management, asset management, or investment advisory.* Audited financial statements of the Sponsor for the previous financial year.* Details of any previously floated SEBI-registered AIFs or Venture Capital Funds. |
| Investment Manager Details | * Contact details of the Manager's registered office and principal place of business.* Name, direct phone number, and email of the Manager's contact person.* Legal structure of the Investment Manager and date of incorporation.* Individual Manager: Brief profile and professional qualifications.* Non-Individual Manager: Shareholding pattern, partnership interests, and profiles of all Directors/Partners.* Identity and Address Proof of the Manager and its Directors/Partners.* History of SEBI registration of the Investment Manager.* Experience of the Manager in capital pools, asset management, fund management, investment advisory, or securities dealing.* Audited financial statements of the Manager for the previous financial year.* Details of all AIFs or Venture Capital Funds previously managed or advised by the Manager. |
| Business Plan & Investment Strategy | * Stated investment objective, style, and strategy of the fund.* Targeted class of investors.* Targeted sectors and industries for investment.* Proposed fund corpus size.* Proposed fee structures payable to the Sponsor and Investment Manager.* Stated tenure of the fund or scheme.* Detailed disclosure on the proposed use of leverage by the Category III AIF. |
| Past Regulatory Actions | * Details of any outstanding litigation in the securities market and orders passed against the Applicant, Sponsor, Trustee, or Manager for securities law violations.* Details of any litigation having a material adverse effect on the applicant's business.* Full details of any previous refusal, suspension, or cancellation of registration certificates by SEBI. |
| Declaration | * A formal, signed declaration by the Applicant, Sponsor, and Investment Manager confirming that they are "fit and proper" persons under the regulations. |
5.2.4 In-Principle Approval
If SEBI is satisfied that the applicant meets the eligibility criteria and has submitted a complete application, but certain legal documents (such as the registration of the Trust Deed or Partnership Deed) are pending final execution, SEBI may grant an In-Principle Approval.
| Stage | Step | Key Requirement / Action |
|---|---|---|
| 1 | Application — Form A | Submit the AIF registration application to SEBI |
| 2 | In-Principle Approval by SEBI | SEBI grants in-principle approval, subject to applicable requirements |
| 3 | Within 6 Months | Complete registration of the required legal deeds/documents; no capital drawdown during this period |
| 4 | Final Registration | Obtain the final AIF registration certificate from SEBI |
Conditions of In-Principle Approval
The grant of In-Principle Approval is subject to the following regulatory conditions:
- Deed Registration Timeline: The applicant must ensure that the Trust Deed or Partnership Deed, as applicable, is duly registered under applicable law within 6 months from the date of receiving the In-Principle Approval.
- No Capital Drawdown: After receiving the In-Principle Approval, the applicant is permitted to approach investors to raise capital commitments, but must not call down or accept any money from investors until the final Certificate of Registration is issued by SEBI.
5.2.5 Conditions of Registration
The final Certificate of Registration (issued in Form B) is subject to continuous compliance with several conditions:
- Continuous Compliance: The Category III AIF must comply with all provisions of the SEBI (Alternative Investment Funds) Regulations, 2012, and circulars issued thereunder on an ongoing basis.
- Permitted Activities Only: The Category III AIF must carry out only those activities that are permitted for alternative investments.
- Prompt Information Updates: The AIF must immediately inform SEBI if any information previously submitted is found to be false or misleading in a material manner, or if there is any material change in the information provided.
- No Category Changes: Once registered under a particular category (Category III), the AIF cannot change its category subsequent to registration without receiving explicit prior approval from SEBI.
5.2.6 Refusal of Registration
If SEBI determines that the applicant does not meet the eligibility criteria or has failed to comply with the application conditions, it may refuse to grant registration.
Procedure for Refusal
- Opportunity of Being Heard: SEBI must provide the applicant with a reasonable opportunity of being heard before rejecting the application.
- Communication Timeline: The final decision to refuse registration must be communicated to the applicant within 30 days of the decision.
- Consequences of Refusal: Upon receiving the communication of refusal, the applicant must immediately cease to carry on any AIF activities. However, the refusal of registration does not affect the existing liabilities of the applicant towards its investors under applicable law, Trust Deeds, or client agreements.
Key Terms and Concepts for Exam Prep
Private Placement
The process of raising capital commitments from sophisticated investors without making a public offer. For AIFs, this is the only permitted fundraising route.
Form A
The prescribed SEBI application form used by applicants to apply for registration as an Alternative Investment Fund.
Form B
The official Certificate of Registration granted by SEBI once the AIF application is approved.
Fit and Proper Person
The regulatory standard of integrity, financial solvency, and clean record required of Sponsors, Managers, and Trustees under Schedule II of the SEBI (Intermediaries) Regulations, 2008.
Key Investment Team
The professional team employed by the Investment Manager to make investment decisions. At least one key member must hold a relevant professional qualification and have cleared the NISM Series XIX-C Certification Exam.
💡 Quick Revision Nudge
- Category III AIF Registration Fees: Application Fee is Rs. 1,00,000, and the final Registration Fee is Rs. 15,00,000.
- Registration Validity: Registered AIFs cannot change their categorisation after registration without SEBI's prior approval.
- In-Principle Approval: Valid for registering deeds within 6 months; capital commitments can be accepted, but no capital drawdown is allowed until the final registration certificate is received.