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SEBI Introduces Flexibility in Pro-rata Rules for Alternative Investment Funds-AIFs
Moneylife Digital Team 16 December 2024
Investor Interest
Market regulator Securities and Exchange Board of India (SEBI) has introduced significant changes to the operational framework of alternative investment funds (AIFs) by relaxing the mandatory requirement of maintaining pro-rata rights in certain scenarios. These changes, announced through a circular, aim to enhance operational flexibility, while ensuring transparency and protecting investor interests, SEBI says.
 
Pro-rata rights, which ensure that investor rights in an AIF scheme are proportional to their commitments, will no longer be mandatory in specific situations. For instance, the market regulator says investors who are excused or excluded from participating in particular investments are exempt from maintaining pro-rata rights for those investments and their distribution proceeds. Similarly, investors who fail to meet their contribution obligations will not be entitled to pro-rata rights, it added.
 
Another key exemption applies to sharing profits, such as carried interest, between investors and fund managers or sponsors. According to SEBI, as outlined in contribution agreements, these arrangements do not require adherence to the pro-rata principle.
 
To prevent misuse of these provisions, the market regulator has introduced safeguards alongside these exemptions. “Certain entities, such as government-backed organisations and development financial institutions, are permitted to opt for junior or subordinate units. These units allow such investors to accept lower returns or higher risks compared to other investors in the fund. However, these arrangements must be transparently disclosed in the fund’s private placement memorandum (PPM),” SEBI says.
 
Further, the market regulator says AIFs with senior-junior priority distribution structures issued before these amendments cannot accept new investor commitments or make fresh investments unless they receive explicit exemptions from SEBI. 
 
Additionally, breaches of investment limits caused by compliance with these rules will not be treated as regulatory violations, provided such breaches are documented in compliance reports.
 
The changes come from SEBI’s 18 November 2024 amendments, which introduced the principle of pro-rata and pari-passu rights for investors. These rules were designed to ensure that investors in an AIF scheme have rights proportional to their investments in terms of participation in fund investments and distribution of proceeds. The latest exemptions offer greater flexibility to address scenarios where rigid adherence to pro-rata rights might not be practical.
 
In a separate circular, SEBI has clarified that the corporate debt market development fund falls under category-1 AIF.
 
This came after the regulator received representation to provide clarity on the classification of CDMDF under one of the defined categories under the AIF Regulation.
 
The CDMD Fund acts as a backstop facility for the purchase of investment-grade corporate debt securities to instil confidence among the participants in the corporate debt.
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