The rules, which came into effect in December 2024, were designed to ensure equal treatment of investors, but many in the industry say they are too inflexible and may disrupt existing fund structures and global investor participation, experts said.
AIFs—private pools of capital that invest in startups, real estate, and unlisted companies—have become a major vehicle for capital formation in India. As of 31 March 2025, AIFs had invested ₹5.38 trillion, according to Sebi data. Of this, real estate accounted for ₹69,896 crore, IT services for ₹34,553 crore, and NBFCs for ₹25,564 crore.
The 13 December Sebi circular mandates that all AIF investors must be treated equally, both in how capital is drawn down and how returns are distributed.
This is based on two key principles: pro-rata rights, which require profits and losses to be shared in proportion to each investor’s committed capital; and pari-passu rights, which ensure all investors are treated equally, unless a specific exemption applies.
The rules were meant to bring clarity and fairness to the AIF space. But they have also cast uncertainty over existing fund structures, especially those involving differentiated rights, preferred investor classes, or global institutional limited partners (LPs).
Before the rule change, private funds had more leeway to tailor rights for different investors. Some offered priority distribution models where “senior” investors received returns before “junior” ones, often in exchange for taking on less risk. While Sebi always promoted fair treatment in spirit, these practices were not explicitly restricted until now.
The regulator first signalled discomfort with these structures in 2022, when it paused fundraising by funds using such waterfall distribution models. The December circular went further, formalizing a uniform treatment requirement and narrowing the scope for deviation.
Seeking clarity on real-world impact
Since then, legal and industry experts have warned that the rules, though well-intentioned, could stifle fund design and discourage foreign participation.
“The Sebi circular on pro-rata and pari-passu rights for AIF investors was brought to bring clarity to fund structuring, aiming to ensure fairness and uniformity in investor rights, while carving out limited exceptions for sponsors and other strategic investors,” said Moin Ladha, partner at Khaitan & Co.
Ladha noted that the transition has raised difficult questions about how the rules affect legacy commitments and deal terms.
“Since its issuance, however, several industry stakeholders have raised concerns regarding its impact on legacy fund commitments and other commercial arrangements necessary for making investment viable,” he said.
“While Sebi has not issued a formal clarification so far, it has usually been proactive in engaging with the industry to address practical implementation challenges,” Moin added.
Industry participants are also seeking clarity on how these rules apply to multi-layered structures, and to Employee Welfare Trusts (EWTs)—entities used by some funds to allocate carried interest or profit-sharing to employees, Moin noted.
The circular does allow a few carve-outs. Fund sponsors and managers, for instance, can make subordinated investments—meaning they take more risk and are paid last. Large Value Funds (LVFs), which collect ₹70 crore or more from each investor, can also offer special terms, so long as they’re disclosed upfront in legal documents.
Even so, legal experts say these exceptions are too narrow to accommodate common practices in the industry.
“Regulatory clarity on the ‘pro-rata’ part of the December 13, 2024, Sebi circular would go a long way in aligning legal expectations with practical realities for AIFs,” said Nandini Pathak, partner, Bombay Law Chambers.
She pointed out that global funds routinely use different allocation methods depending on the phase of investment. While capital calls may be based on outstanding commitments, distributions often follow the ratio of actual capital invested.
“Institutional LPs also prefer allocation rules for distributions to be on invested capital ratio basis, as is evident from the ILPA standard term sheet,” she said, referring to the guidelines followed by large international investors.
Experts argue that Sebi should allow Indian AIFs to adopt such globally accepted practices—provided they’re clearly spelled out in the fund’s Private Placement Memorandum (PPM), which lays out terms, risks and investment strategy for potential investors.
Sebi response in the works
To address the feedback, Sebi has formed a Standard Setting Forum (SSF), which is reviewing suggestions and working on a list of investor rights that AIFs may offer on a differential basis without violating the equal treatment rule.
“The SSF is looking at detailed industry feedback and certain reforms are expected,” said Vivaik Sharma, Partner at Cyril Amarchand Mangaldas.
“The SSF has specified a positive list of rights which may be provided by AIFs on a differential basis. It should be clarified that any additional rights may be offered to specific investors of AIFs so long they are not prejudicial to any other investor.”
Some concerns go beyond distribution rights. Experts have pointed to other commercial nuances the rules currently overlook—such as profit-sharing with advisors or offsetting fund expenses across different legal entities in a master-feeder structure, a common setup for funds with international investors.
“When dealing with master-feeder structures where fund expenses are incurred at both levels (main fund and sub-funds), allowing for offsets of the relevant amount of fund expenses incurred at the feeder level when considering the proportionate allocation of fund expenses among investors at the master fund level, are some of the areas for reconsideration,” said Clarence Anthony, founder of Clarence & Partners.
“Most of these could be addressed by amending the Implementation Standards for offering of differential rights to select investors of an AIF.”
People familiar with the matter said Sebi is currently reviewing all industry feedback and may issue formal clarifications or revisions in the coming months.
