Securities and Exchange Board of India recently amended the Alternative Investment Fund (AIF) Regulations on November 18, 2022, aiming to standardise investor rights and ensure equitable treatment across AIFs. The new framework mandates that each investor in an AIF is entitled to rights pro rata to its capital commitment for each investment and distribution, subject to certain exceptions. The amendment further states that existing AIFs that do not comply with this requirement will be governed by rules that SEBI is expected to prescribe soon. Although SEBI is yet to officially notify these rules, it is imminent that they will be published soon.
The new rules may allow certain specified government, multilateral investors, or developmental financial institutions to partake in the profits and losses of an AIF on the terms that are not pro rata to their capital commitment. Additionally, existing AIFs that do not provide pro rata rights to their investors may be prohibited from raising fresh commitments or investments. This restriction was already under temporary suspension under the provisions of the AIF master circular. The amendments further provide that all investors in an AIF should have pari-passu rights in all respects, implying that their rights should be on an equal footing with those of other investors in the same AIF. However, SEBI may prescribe specific scenarios where differential rights may be offered to select investors, provided these do not dilute the rights of other investors. While these scenarios are yet to be clarified, it is anticipated that the Standard Setting Forum (SFA) will soon outline the specifics.
Notably, large value funds, who require a minimum capital commitment of INR 70 crore per investor, are exempt from this rule and may offer differential rights to its investors on terms beyond the scope specified by SFA. SEBI will also issue detailed guidelines for existing funds that have offered differential terms to investors under ‘side letters,’ specifying how these will be managed going forward. The intent behind this amendment is to restrict the scope of ‘side letters’, which have historically been used by managers of AIFs as tools to negotiate differential rights, such as better economic terms, information rights or co-investment rights, etc., with investors bilaterally. The amendment underscores SEBI’s intent to ensure fair and equal treatment of all investors, allowing deviation only in clearly defined scenarios. However, commitments represent promises by investors to honour capital calls when issued by the manager, and actual contributions can vary due to factors such as defaults on capital call or the exclusion of an investor from a particular investment. SEBI should carve out these instances as exceptions to the pro rata rule.
In industry practice, an investor’s effective interest in the fund is typically determined by its net invested capital, which refers to the actual capital deployed for that investor after deducting fees and expenses. A lack of alignment with this widely accepted approach could discourage investors, particularly institutional ones, from negotiating preferential terms under their fund documents.
