Sebi introduces flexibility in pro-rata rights for AIF investors

To enhance flexibility, markets regulator Sebi on Friday introduced exemptions to the requirement of maintaining pro-rata rights in investments and distribution of proceeds under the alternative investment funds (AIF) rules. Under this, pro-rata rights will not apply to cases where investors are excused or excluded from specific investments; fail to meet their contribution obligations, or share profits (such as carried interest) with fund managers or sponsors, Sebi said in a circular.

Furthermore, specific entities, including government-backed organisations and development financial institutions, may opt for junior or subordinate units, accepting lower returns or higher risks compared to other investors.

Safeguards have also been introduced to prevent misuse of funds in such scenarios, ensuring robust investor protection.

These measures are aimed at ensuring fairness, transparency, and flexibility in AIF operations, catering to diverse investor needs while protecting their rights.

The regulator, on November 18, amended rules governing AIF to ensure the maintenance of pro-rata and pari-passu rights for investors.

As per the amendment, investors in an AIF scheme must have rights proportional to their investment (commitment) in terms of participation in investments and distribution of proceeds. In its circular, Sebi has specified that “the requirement of maintaining investors’ rights pro-rata to their commitment to the scheme shall not be applicable in an investment of a scheme and distribution of proceeds of the investment to the extent an investor has been excused or excluded from participating in the said investment or an investor has defaulted on providing his/her pro-rata contribution for the said investment”. “Further, the requirement of maintaining pro-rata rights of investors in the distribution of proceeds of investments of a scheme shall not be applicable to the extent returns or profit on the investments is shared by an investor with the manager or sponsor of the AIF in terms of contribution agreement executed between them,” it added.

Sebi said that certain entities like fund managers, sponsors, and government-backed organisations may accept lower returns or higher losses through junior/subordinate units.

These should be transparently disclosed in the fund’s Private Placement Memorandum (PPM).

AIFs with priority distribution models (senior/junior units) issued before the amendment cannot accept fresh commitments or make new investments unless exempted.

Further, breaches of investment limits due to compliance will not be considered violations but must be documented in compliance reports.

In a separate circular, Sebi has clarified that the Corporate Debt Market Development Fund falls under Category I 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 Corporate Debt Market Development 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 market during times of stress and to generally enhance secondary market liquidity by creating a permanent institutional framework for activation in times of market stress.