SEBI issues draft guidelines clarifying investor rights and operational rules for AIFs

The Securities and Exchange Board of India (SEBI) on Friday released a draft circular seeking public feedback on the operational aspects of maintaining pro-rata and pari-passu rights for investors in Alternative Investment Funds (AIFs). The proposed framework aims to bring clarity and uniformity to how fund proceeds are distributed and how investor rights are calculated within different types of AIF structures.

In simple terms, pro-rata means that investors share profits or proceeds in proportion to their investment, while pari-passu implies that all investors are treated equally, with none enjoying preferential treatment. SEBI has proposed that for closed-ended AIF schemes, investor rights during the distribution of proceeds should be determined either based on their total capital commitment or undrawn commitment, depending on what is clearly disclosed in advance.

According to the draft, “Investors of a scheme shall have rights in the distribution of proceeds of an investment pro-rata to their contribution to such investment, or pro-rata to their contribution on a time-weighted basis, as disclosed in the private placement memorandum (PPM) of the scheme.” SEBI also emphasized that once disclosed, the chosen methodology cannot be changed during the fund’s tenure. Importantly, investors excluded from a specific investment cannot have their unused commitments diverted elsewhere, and the framework should ensure no single investor breaches the concentration limits in an investee company.

The regulator clarified that open-ended Category III AIFs, where investors can enter or exit freely, may not need to apply pro-rata drawdowns. However, proceeds must still be distributed in proportion to the units held. If these schemes invest in unlisted securities, the same pro-rata principles as closed-ended schemes will apply. For existing investments made before December 13, 2024, the current terms already agreed upon by investors will continue to govern distributions.

SEBI also stated that carried interest or profit shares that investors allocate to fund managers are exempt from the pro-rata requirement. AIF managers will be required to maintain detailed records demonstrating compliance, and trustees must confirm the same in their periodic compliance reports. The draft circular follows amendments made to the AIF Regulations in November 2024, and SEBI has invited public comments until November 28, 2025.

Understanding AIFs

Alternative Investment Funds (AIFs) are privately pooled investment vehicles designed for high-net-worth and institutional investors seeking exposure beyond traditional equities and debt. These funds invest in asset classes such as private equity, venture capital, real estate, hedge funds, and debt instruments. While AIFs offer higher return potential and diversification, they are relatively illiquid, complex, and carry higher risks.

AIFs are classified into three categories under SEBI’s 2012 regulations:

Category I: Focuses on socially or economically beneficial sectors like venture capital, infrastructure, and SME funds.

Category II: Includes private equity, real estate, and debt funds focused on long-term capital appreciation.

Category III: Employs complex trading and hedge fund-like strategies for short-term gains and is allowed to use leverage.

Co-Investment Framework

In June 2024, SEBI further eased norms to enhance operational flexibility for AIFs by allowing co-investments in unlisted securities through a Co-Investment Vehicle (CIV) model. Under this framework, AIF investors can co-invest directly in portfolio companies alongside the fund, subject to conditions. Each CIV scheme must have its own bank, demat, and PAN accounts, and co-investment opportunities will be available only to accredited investors.

These combined measures underscore SEBI’s continued efforts to balance investor protection, transparency, and operational flexibility in India’s growing alternative investment ecosystem.

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