AIFs include private equity, venture capital and hedge funds, in addition to other private instruments that invest in real estate and commodities. Such investments generally carry higher risk and are intended for high net worth or high net worth investors.

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The Securities and Exchange Board of India (Sebi), in its circular dated October 8, introduced stricter due diligence requirements for AIFs, their managers and key officers, to prevent circumvention of regulations and strengthen the monitoring of these funds.

Benefits for Qualified Buyers

Sebi Circular 8 directs AIFs to ensure that their investors and investments comply with various laws, including preventing ineligible investors from accessing Qualified Institutional Buyer (QIB) and Qualified Buyer (QB) benefits. These include large and sophisticated investors like banks, mutual funds, pension funds, HNIs, family offices, venture capital firms and AIFs.

AIFs are designated as QIBs under the Sebi Regulations (Question of Capital and Disclosure Requirements) and as QBs under the Securitization and Reconstruction of Financial Assets and Enforcement of Security Interests Act (Sarfaesi Act), which which makes them eligible to invest in specific financial instruments such as collateral receipts. issued by Asset Reconstruction Companies (ARCs).

Under the new circular, AIFs must now carry out extensive due diligence when an investor contributes 50% or more to the corpus of a scheme, thereby ensuring compliance with Sebi and Sarfaesi regulations.

Permanent renewal of stressed loans

The circular addresses concerns about RBI-regulated lenders using AIFs to “future-proof” stressed loans or circumvent asset classification and provisioning rules.

Last year, in a speech to bank directors, the Governor of the Reserve Bank of India (RBI) had warned against rolling over loans permanently. Earlier this year, the RBI issued a circular prohibiting regulated entities from investing in shares of AIFs having downstream investments, directly or indirectly, in a “debtor company” in order to restrict the structures that could be used by such entities, including non-banking financial companies (NBFCs). ), for a “perpetuity” of the loans. The current Sebi circular also addresses the same concern.

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AIFs will be required to carry out due diligence if 25% or more of the scheme corpus comes from RBI-regulated investors or if they exercise significant influence over investment decisions. This aims to prevent AIF managers from indirectly allowing RBI-regulated lenders to take ownership or control of the companies they invest in beyond what is permitted. Sebi has directed AIFs to apply these norms to existing investments by April 2025.

While due diligence for QIBs and QBs will not be too burdensome, monitoring the evergreening of RBI-regulated lenders could be more complex, according to Puneet Sharma, CEO of Whitespace Alpha. “The responsibility lies with the investor or group entities. to inform the manager if they belong to the same group structure, which does not always happen in time.”

Sharma explained that due diligence checks whenever an AIF’s investor pool exceeds 25% or 50% of the program’s assets under management (AUM) could extend the onboarding timeline, requiring additional verification steps .

Foreign investments in India

According to the October 8 circular, due diligence must align with the standards set by the Standard Setting Forum for AIFs (SFA), created by Sebi. For foreign investors or funds based outside India, this should be done on a transparent basis by assessing the overall profitability of the investment structure. An investor who fails these checks must be excluded from the system.

Sharma said the rigorous internal processes required could add complexity to monitoring and reporting. “Managers will need to assess whether to accept investments from other AIFs or funds based in the IFSC or outside India,” he said. “This decision depends on the operational ability of the fund to perform the necessary due diligence and manage the additional compliance burden.”

Cross-border investments

The Sebi circular also requires entities from countries sharing a land border with India to obtain government approval before investing in Indian companies.

In any AIF scheme in which 50% or more of the corpus is derived from such entities, due diligence must be carried out in accordance with the standards set by the SSF. If an AIF holds 10% or more of the equity-linked securities of a company in which it invests, it must declare this to its custodian within 30 days of the investment. Depositories are required to report all relevant information to Sebi by May 7, 2025.

What the experts say

While acknowledging the added burden of compliance, Brijesh Damodaran, Founding Partner, Auxano Capital, highlighted the importance of maintaining the integrity of the regulatory ecosystem. “Not all money is welcome,” he said, emphasizing the need for prudent regulations to support sustainable investment growth.

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Some experts predict that the compliance and reporting burden could deter large investors from some AIFs.

According to Sharma, for many AIFs, particularly those with a diverse investor base, these new regulations may not have a significant impact on day-to-day operations or investment decisions. However, AIFs with a targeted base of large investors will find themselves devoting more resources to compliance and reporting. “These additional charges could affect their attractiveness as an investment vehicle, particularly for high-net-worth investors or institutional clients looking for efficient and flexible structures.”

AIFs focused on niche opportunities or those catering to large investors with a higher risk appetite might find the additional diligence unattractive, he said. “This could encourage these investors to consider alternative vehicles for their investments.”

According to Vivaik Sharma, partner at Cyril Amarchand Mangaldas, the circular aims to prevent FIAs from being used to circumvent regulations, particularly by entities regulated by the RBI. “Non-compliance could be considered a regulatory violation, reinforcing the importance of the new compliance standards. »