(MENAFN- Live Mint) The Securities and Exchange Board of India (Sebi) has provided relief to Alternate Investment Funds (AIFs) over how to apply the new“pro-rata rights” rule introduced in December 2024, in a consultation paper released on Friday.

The market regulator seeks to clarify how AIFs should maintain pro-rata rights of investors while investing and distributing returns, a requirement that has raised concerns in the industry on operational implementation. Pro-rata rights require profits and losses to be shared in proportion to each investor's committed capital.

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The paper proposes that AIFs may interpret an investor's“commitment” either as the total amount promised to the fund or as the“undrawn commitment”-the portion not yet called by the fund- when drawing down capital and distributing investment proceeds. This flexibility is expected to help funds better align their investment cycles with investor commitments, without breaching pro-rata requirements.

Under the 2024 circular, all investors in an AIF scheme were supposed to receive returns in the same proportion to their commitment. The lack of clarity on how to implement these rules had led to industry-wide uncertainty. AIFs collect funds from investors to invest in assets beyond traditional financial assets like stocks, bonds, or mutual funds.

Sebi also clarified that existing AIF schemes, which already follow a specific drawdown structure, can continue with the approach until the end of their tenure. Those following other methodologies have to align with one of the approved methods for new money or future capital calls.

The regulator also clarified that AIFs that had made investments on or before 13 December 2024, the date of the previous circular, may distribute proceeds from those investments according to the terms already disclosed in their Private Placement Memorandum (PPM) and other fund documents. This clarification ensures that funds are not forced to retroactively change distribution waterfalls, which could have led to legal and operational challenges.

Distribution waterfall indicates the order and method by which an investment fund shares returns among its investors.

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The consultation paper also provides relief to open-ended Category III AIF, where investors can enter or exit the scheme at any time. Sebi has now stated that the pro-rata drawdown rule will not apply to such schemes, since they issue and redeem units at the fund's Net Asset Value (NAV). Instead, these funds must ensure that any distribution of proceeds is made pro-rata to the units held by each investor at the time of payout.

However, if such open-ended schemes invest primarily in unlisted securities, they will still have to comply with the broader conditions on pro-rata investment and distribution.

Alternative investment funds collect funds from other investors to invest in companies or projects. Category I AIFs include venture capital and infrastructure funds, while private equity and debt funds fall under Category II AIFs. Category III AIFs such as hedge funds have a higher risk appetite with aggressive investment strategies such as using algorithms for automated high-frequency stock trading.

Though the clarifications and changes brought relief to officials in the AIF industry, some problems remain unaddressed.

“The new consultation paper by Sebi addresses many of the issues faced by AIFs. But investors with differential fee arrangements worry that the new pro-rata income distribution rule undermines their fee advantage,” said a senior lawyer on the condition of anonymity.

While such differential fees are permitted as a valid right, the pro-rata requirement effectively nullifies them. These investors may also never be fully drawn down, which may create potential accounting complications.

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Finally, AIFs with previously compliant but varied structures and distribution models are now in limbo, awaiting guidance on how to unwind existing agreements.“The previous flexibility to structure is now undone, resulting in tough discussions between the AIF and investors. Many hope that the implementation standards by the SFA (Standard Setting Forum for AIFs) would address such concerns,” said the lawyer quoted above deadline for public comments on the paper is 28 November 2025.

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