SEBI Tightens Grip on Alternative Investment Funds: Master Circular Mandates Enhanced Governance and Rigorous Performance Benchmarking

SEBI Tightens Grip on Alternative Investment Funds: Master Circular Mandates Enhanced Governance and Rigorous Performance Benchmarking​

The Securities and Exchange Board of India (SEBI) has released a comprehensive new Master Circular for Alternative Investment Funds (AIFs), setting stringent standards across the entire investment lifecycle. This Master Circular supersedes the previous guidelines, consolidating and refining regulatory requirements from all AIF-related circulars issued up to May 31, 2026. The issuance signals SEBI’s continued focus on investor protection while promoting industry development within the sophisticated AIF sector.

Governance and Operational Mandates for Fund Managers​

The new regulations impose heightened accountability on the Manager, Sponsor, and Trustee of every AIF scheme. A mandatory Compliance Test Report (CTR) must be prepared by the Manager at the end of each financial year, detailing compliance with all relevant AIF Regulations and associated circulars. This CTR must be submitted within 30 days to the designated trustee or sponsor.

Furthermore, the Master Circular details robust governance structures. Managers are required to appoint a Compliance Officer who must hold certification from the National Institute of Securities Market (NISM) by passing the relevant examinations. With effect from January 01, 2027, only those with this specific qualification may be appointed as compliance officers.

Investor Protection and Transparency Requirements​

Transparency regarding fund operations and risks has been significantly enhanced for all AIFs. All schemes must disclose a detailed distribution waterfall in their Private Placement Memorandum (PPM). Critically, the PPM must include a thorough disciplinary history of the AIF, its sponsor, manager, and associated directors or partners covering the past five years.

These disclosures are intended to ensure investors can make an informed decision regarding the investment. Moreover, all AIFs are mandated to provide an Investor Charter (Annexure 4) outlining grievance redressal mechanisms, alongside disclosing complaint data on each scheme. This mandate aims to streamline the grievance mechanism and foster greater market confidence.

Investment Limits and Market Exposure Standards​

The circular provides detailed parameters for various investment activities within the AIF ecosystem. For instance, Category I and II AIFs are restricted from engaging in leverage or borrowing funds, except for meeting temporary operational requirements and day-to-day needs, subject to defined limitations. This constraint applies up to 30 days, limited to no more than four occasions annually.

Regarding derivatives exposure, specific conditions apply across categories. While Category I and II AIFs can only use Credit Default Swaps (CDS) for hedging purposes, Category III AIFs may trade CDS for both hedging and other purposes, provided the effective leverage remains within prescribed limits.

Rigorous Reporting and Valuation Standards​

The Master Circular introduces intensive standards concerning investment valuation and performance reporting across all categories of AIFs. Managers must adhere to a standardized approach to portfolio valuation, which includes disclosing the valuation methodology used for every asset class in their PPM.

A significant mandate requires that managers ensure fair and appropriate valuation, even if established procedures do not yield such results. If a deviation occurs, the Manager must document the rationale. Furthermore, any material change exceeding 20% between two consecutive valuations or over 33% in one financial year necessitates informing investors about all generic and specific reasons for the movement.

Specialized Guidelines for Angel Funds and SSFs​

The regulations provide specialized norms for certain fund types to cater to niche market segments. For Angel Funds, the circular confirms that these funds must conduct investments directly without having to launch a separate scheme. They are also required to maintain records of all term sheets and investment participation details.

Special Situation Funds (SSFs), which operate as Category I AIFs focusing on 'special situation assets,' must meet minimum corpus requirements set by SEBI, such as accepting an investment of not less than INR 10 crore from a general investor. This focus ensures that SSF activities align with their restorative market objectives.

Overseas Investment and Allocation Limits​

AIFs engaging in overseas investments are subject to several strict guidelines to mitigate risks. All offshore investments must be limited to no more than 25% of the scheme’s investable funds, which is capped under a combined global limit of USD 1500 million for AIFs and Venture Capital Funds.

The allocation of this overseas investment limit is managed via an application process with SEBI, following a first come first serve basis. Reporting obligations are also strict; utilizing the limits must be reported within 5 working days on the SEBI Intermediary portal. Any sale or divestment of these foreign assets must be reported within 3 working days to update the overall limit status.