SEBI’s new AIF rules decoded: 10 major changes investors and fund managers should know

The Securities and Exchange Board of India (SEBI) has introduced a new framework that gives Alternative Investment Funds (AIFs) greater flexibility during the winding-up process while also creating a new category called “Inoperative Fund” for schemes facing unresolved liabilities.

The move follows amendments made to the SEBI (Alternative Investment Funds) Regulations on April 18 and is aimed at helping funds manage pending tax, legal and regulatory issues more efficiently before surrendering their registration.

For investors and fund managers, the changes could have a significant impact on how liquidation proceeds are handled after a fund reaches the end of its permissible life.

Here are the key highlights:

1. AIFs can now retain liquidation proceeds beyond their fund life

SEBI has allowed AIFs to hold back a portion of liquidation proceeds even after the expiry of their permissible fund life. This can be done if the fund receives official communications indicating potential tax, legal or regulatory liabilities that may arise in the future.

2. The rule covers both actual and potential liabilities

The regulator has clarified that the provision is not limited to confirmed claims. It also applies to situations where liabilities may arise from ongoing proceedings, investigations or disputes, even if no final demand has yet been raised.

3. A wide range of official communications qualify

Eligible communications may include notices, summons, show-cause notices, reassessment notices, investigation-related communications and claims received from regulators, tax authorities, law-enforcement agencies, courts, investors or counterparties.

4. Litigation-related claims are specifically covered

SEBI has clarified that litigation-related communications from tax authorities, regulators, courts, investors, counterparties or law-enforcement agencies can justify the retention of funds if they indicate potential legal, tax or regulatory liabilities.

5. Investor approval can also permit retention of funds

Funds can retain proceeds for anticipated litigation or tax-related liabilities if at least 75% of investors by value approve the proposal. This provides managers with an additional mechanism to safeguard investor interests while dealing with unresolved matters.

6. Operational expenses can be funded using retained proceeds

SEBI has also permitted AIFs to retain funds to meet residual winding-up-related operational expenses. Such expenses must be backed by invoices, supporting documents or records of comparable expenditure incurred in previous years.

7. Retention for operational expenses is capped at three years

Where funds are retained solely for residual winding-up-related expenses, the retention period cannot exceed three years from the end of the permissible life of the AIF or the relevant scheme.

8. SEBI has introduced a new ‘Inoperative Fund’ category

AIFs that have liquidated all investments but continue to hold retained proceeds or remain registered because of pending litigation can apply for “Inoperative Fund” status while they complete the closure process.

9. Inoperative Funds will face restrictions but receive compliance relief

Funds operating under this status will not be allowed to make fresh investments, launch new schemes or charge management fees. Retained proceeds can only be invested in instruments permitted under AIF regulations.

At the same time, SEBI has exempted such funds from several compliance requirements, including quarterly and annual activity reports, compliance test reports, performance benchmarking disclosures, audits of private placement memorandum (PPM) terms and certain certification requirements relating to key investment personnel.

10. Additional disclosures and reporting will be mandatory

When seeking investor approval for retaining funds against anticipated liabilities, AIF managers must disclose both the amount proposed to be retained and the expected duration of retention.

Further, AIFs classified as Inoperative Funds due to retained monies for anticipated liabilities will have to submit an annual status report to both SEBI and investors detailing retained funds and outstanding liabilities.

Additional provisions investors should know

SEBI has directed the Standard Setting Forum for AIFs (SFA) to formulate implementation standards and standardise eligible operational expense heads in consultation with the regulator.

Once all liabilities have been settled and the retained proceeds distributed to investors, the relevant scheme will be wound up in accordance with AIF regulations.

The regulator has also extended these benefits to Venture Capital Funds registered under the erstwhile SEBI (Venture Capital Funds) Regulations. Such funds can retain proceeds beyond their permissible life and seek Inoperative Fund status, provided they comply with the same conditions applicable to AIFs.

Additionally, AIFs whose schemes have not retained funds beyond their permissible life but wish to continue operating while awaiting the outcome of pending litigation may also apply for Inoperative Fund status. However, they too will be barred from launching new schemes or charging management fees.

Disclaimer: This story is for educational purposes only. Please consult with an investment advisor before making any investment decisions.