Blasé Capital alternate issues

Over the past year or so, the stock market regulator, Sebi, seems worried about AIFs, or alternate investment funds. Even recently, the Sebi chief hinted at possible changes that were required in its sub-ecosystem, even as it released a consultation paper largely related with the winding up of AIFs. Most experts feel that the regulator wants to tighten the screws, or its oversight over AIFs to tackle multiple issues. It has resorted to measures such as mandated due diligence, direct plans, and stricter custody to ensure investor protection. However, these may not be enough, and Sebi wants to do more, even as it wishes to adopt a hands-off approach to ensure minimal interference. Caught between the two extremes, the regulator hopes to somehow keep the AIFs in check. In recent speeches, Sebi chairman, Tuhin Kanta Pandey, emphasised that AIFs were a “crucial pillar” in the country’s capital market, and had nearly Rs 16 lakh crore in commitments. Yet, he simultaneously insisted that the segment needs to focus on “sound fundamentals over just financial returns, and improve disclosure standards.”

One of the major charges against the AIFs is that they are used to bypass the existing regulations and guidelines on sector-specific foreign direct investment (FDI). Foreigners structure their money inflows through specifically-designed vehicles with the Indian managers. This allows the former to circumvent the FDI caps across sectors. According to AI search, “Sebi has flagged this as regulatory arbitrage, prompting stricter investor due diligence, and investment oversight to prevent misuse.” The use of Indian or domestic managers, who are shown as investors, allow the foreigners to hide their identities. For all purposes, the investments are regarded as domestic by legal and regulatory entities. This allows illegal FDI flows in restricted areas. One of the oft-used purposes of the AIFs to hide FDI, and masquerade as domestic investment is seen in the highly-sensitive banking sector. Since 2024, Sebi introduced several measures and circulars to curtail such practices, with “enhanced due diligence on beneficial owners.” According to Sebi, INR 1 lakh crore, or a huge percentage, is used to bypass FDI.

AIFs were increasingly used by the banks and NBFCs to evergreen stressed loans. This practice became common after the popularity of the AIFs, and the huge impact of the new insolvency law, which made it easier for any financial creditor to drag a defaulting firm to the bankruptcy table. Banks would invest in AIFs, which would lend money to a stressed borrower, which enabled the borrower to repay the original loan, with the bank avoiding a possible bad loan. Hence, the central bank tightened the regulations to prevent this. Now, banks cannot invest in AIFs, which have invested in firms that have loan exposure with the banks over the past 12 months. In case of the breach of policy, the bank needs to get out of investment in 30 days. “In March 2024, the RBI clarified that equity-based downstream investments are generally excluded from this restriction, aiming to distinguish genuine investments from evergreening attempts,” explains AI-linked search.

In March 2024, a note by a legal firm, stated that many NBFCs ran “pillar-to-post in a major attempt to transfer or sell their holdings in AIFs. Most of their attempts have either been futile or come at a huge cost as investors demand sizable discounts…. The plight of NBFCs stem from a central bank directive… to forgo investing in AIFs should the downstream investments be a debtor company…. Regulated entities, such as banks and NBFCs… have been given 30 days to assess their investee AIFs’ portfolios, and liquidate their investments in the AIFs, or else male 100 per cent provisioning (of the loans). This poses major challenges for NBFCs and banks, as the transfer of units is highly restrictive. India’s secondary market for AIF units is still at a nascent stage of growth, with few takers having the ability to absorb the units….” However, one is not sure if other practices have cropped up.

There are other charges against the AIFs. In some cases, the funds provide better or preferential terms to the larger investors, which breaches the requisite “proportional, equal-footing principle.” Some experts highlighted that AIFs fail to “properly value debt

securities, often relying on collateral value rather than the debt’s actual worth.” Tax experts contend that several AIFs fail to liquidate their assets within the prescribed period.

This is why Sebi issued a consultation paper for public feedback in February 2026 to deal with this issue. According to a law firm, “The proposal seeks to address challenges faced by AIFs that retain liquidated proceeds beyond the permissible fund life due to pending or anticipated litigation, tax contingencies, or residual operational expenses. The key proposals include: permitting AIFs to surrender their registration while retaining funds, with such AIF schemes being designated as inoperative funds… permitting retention of funds for anticipated liabilities… and permitting retention of funds for operational expenses up to three years.”

Yet Sebi’s Pandey wants more. “AIFs often invest in early-stage and illiquid assets. In such cases, credibility begins with valuations. Weak or opaque valuations erode confidence. When investee companies move towards the public market, valuation concerns can distort price discovery and weaken trust. Therefore, fair valuation matters.”