Introduction

The Securities and Exchange Board of India (SEBI) has implemented its decisions, introducing significant changes to the regulations governing Alternate Investment Funds (AIFs).
These include extending the mandatory custodian appointment to smaller AIFs and requiring the dematerialization of AIF investments.

About Alternative Investment Funds (AIFs)

	Details
Definition	AIFs are privately pooled investment vehicles established in India, collecting funds from sophisticated investors for investing.
Regulation	Governed by the SEBI (Alternative Investment Funds) Regulations, 2012.
Formation	Can be formed as a company, Limited Liability Partnership (LLP), trust, etc.
Investor Profile	Aimed at high rollers, including domestic and foreign investors in India. Generally favored by institutions and high net worth individuals due to high investment amounts.
Categories of AIFs	Category I: Invests in start-ups, early-stage ventures, SMEs, etc. Includes venture capital funds, angel funds, etc. Category II: Includes funds not in Category I/III, like real estate funds, debt funds, etc. No leverage or borrowing except for operational requirements. Category III: Employs complex trading strategies, may use leverage. Includes hedge funds, PIPE Funds, etc.
Fund Structure	Category I and II AIFs must be close-ended and have a minimum tenure of three years. Category III AIFs can be open-ended or close-ended.

Previous Norms: Earlier, the mandatory custodian appointment was required for Category III AIFs and Category I and II AIFs with a corpus exceeding ₹500 crore.
New Extension: As of January 5, this requirement has been extended to all AIFs, regardless of their corpus size.

Amendment to AIF Regulations: SEBI has amended its 2012 AIF Regulations to mandate that AIFs hold securities of their investments only in dematerialized form, with certain exceptions.
Exceptions: These include investments in instruments not eligible for dematerialization and those held by a liquidation scheme of AIF not available in dematerialized form.
Future Provisions: SEBI has also reserved the right to specify other investments or schemes that may be exempt from this dematerialization requirement.

Restrictions on Associates: AIFs can appoint a Custodian who is an Associate of a Manager or a Sponsor of an alternate fund only under specific conditions.
Net Worth and Independence Requirements: These conditions include the Sponsor or Manager having a minimum net worth of ₹20,000 crore and ensuring the Custodian’s independence from the Sponsor or Manager.

Addressing Past Breaches: The latest changes aim to close various regulatory gaps that previously allowed breaches in the spirit of the law and the use of investment vehicles to escape regulatory oversight.
RBI’s Complementary Measures: The Reserve Bank of India (RBI) has also tightened norms for banks and NBFCs investing in AIFs to prevent potential ever-greening and other regulatory circumventions.