The Securities and Exchange Board of India (SEBI) has issued a circular that introduces significant changes regarding the pro-rata and pari-passu rights of investors in Alternative Investment Funds (AIFs). The circular aims to improve transparency, provide flexibility, and protect the interests of investors within AIFs, while also ensuring compliance with SEBI’s broader regulatory framework.
Key provisions and their implications for AIFs and investors
One of the key provisions of the updated SEBI regulations mandates that investors in an AIF scheme must have rights proportional to their commitment in each investment of the scheme, including in the distribution of proceeds. This means that the returns from investments will be distributed to investors based on the size of their contribution to the fund. However, there are specific exemptions:
- Excused or Excluded Investors: If an investor is excluded or excused from participating in a particular investment, they will not have pro-rata rights in that investment.
- Defaulting Investors: Investors who fail to meet their pro-rata contribution to an investment will not be entitled to pro-rata returns.
- Manager or Sponsor’s Share: In cases where the manager or sponsor of the AIF receives a share of the returns (e.g., carried interest), these returns will not be distributed on a pro-rata basis.
The circular introduces flexibility for certain entities to accept returns that are lower or share losses greater than their pro-rata rights. This applies to entities with different risk profiles, such as:
- AIF managers or sponsors
- Bilateral and multilateral development financial institutions
- State-owned entities, including government-backed corporations and sovereign wealth funds
- These entities may choose to subscribe to subordinate units that may have different risk-return characteristics compared to the senior units, thus allowing for more nuanced capital raising strategies.
To ensure compliance, AIFs will need to report details of any differential rights offered to investors. For existing AIFs that have issued differential rights that are not in line with the new standards, managers will need to report these to SEBI and discontinue any rights found to be adverse to other investors.
