Capital Markets: Challenges and Developments

Regulatory Challenges in Alternative Investment Funds (AIFs)


From UPSC perspective, the following things are important :

Prelims level: AIFs and their regulation; Benefits offered.

Why in the News?

In response to tightening regulations impacting operations, the RBI has recommended that investments exceeding 50% of Alternative Investment Funds (AIFs) units by a person resident outside India be treated as Indirect Foreign Investment.


What are Alternative Investment Funds (AIFs)?

  • An Alternative Investment Fund or AIF is any fund established or incorporated in India that is a privately pooled investment vehicle that collects funds from sophisticated investors, for investing by a defined investment policy for the benefit of its investors.
  • AIFs are regulated by the SEBI (Securities and Exchange Board of India).
  • As per the SEBI (Alternative Investment Funds) Regulations, 2012, an AIF can be set up as a trust, a company, a limited liability partnership, or a corporate body.

Who can invest in an AIF?

  • Indian Residents, NRIs (Non-Resident of India), and foreign nationals are eligible to invest in these funds.
  • Joint investors can also invest in AIF. They can be spouse, parents, or children of investors.
  • The minimum investment amount for investors is Rs1 crore for investors. For directors, employees, and fund managers, this limit is Rs 25 lakh.
  • Most AIFs come with a minimum lock-in period of three years.
  • The maximum number of investors in every scheme is capped at 1,000. However, in the case of angel fund, the cap is 49.

Categories of an applicant who can seek registration as an AIF:

  • Category I and II AIFs are required to be close-ended and have a minimum tenure of three years. Category III AIFs may be open-ended or close-ended.

Note: Investment by an Indian company (which is owned or controlled by foreigners) into another Indian entity is considered as Indirect Foreign Investment (IFI). It is also known as downstream investment.

Present Regulatory Landscape:

  • Regulatory Ambiguity: Recent regulatory notes have instilled mistrust in the industry, particularly regarding Foreign Direct Investment (FDI) policy surrounding AIFs, spooking investors and prompting reconsideration of fund deployment strategies.
  • Changing Stance: The regulatory stance has evolved, with amendments in 2015-16 allowing AIFs to attract foreign capital through the automatic route, promoting onshore management and incentivizing Indian fund managers to relocate to India.

Offshore Alternatives:

  • Reason for Offshoring: Offshore funds benefit from a more stable regulatory environment, with considerations for tax implications necessitating careful structuring.
  • Attractive Destination: Gujarat International Finance Tec-City (GIFT City) has emerged as an attractive alternative for managers due to regulatory stability, tax incentives, and proximity to India.


[2020] With reference to Foreign Direct Investment in India, which one of the following is considered its major characteristic?

(a) It is the investment through capital instruments essentially in a listed company.

(b) It is a largely non-debt-creating capital flow.

(c) It is the investment which involves debt-servicing.

(d) It is the investment foreign institutional investors make in Government securities.

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