SEBI Proposes Expanding Investment Opportunities for Category II AIFs

Introduction  

On 07 February 2025, the Securities Exchange Board of India (SEBI) issued a consultation paper proposing to expand the permissible investment methods available to Category II Alternative Investment Funds (Cat II AIFs) under the SEBI (Alternative Investment Fund) Regulations, 2012 (SEBI AIF Regulations). In this update, we have provided a brief overview of the said consultation paper. 

Brief Background 

SEBI, on 20 September 2023, had introduced an amendment to the SEBI (Listing Obligations and Disclosure Requirements) Regulations, 2015 (LODR Regulations) mandating the listed entities that have issued listed non-convertible debentures (NCDs), to list all their NCDs as follows: (i) any NCDs proposed to be issued on or after 01 January 2024, to be listed on the stock exchanges; and (ii) where the NCDs are proposed to be listed on the stock exchanges on or after 01 January 2024, all unlisted NCDs issued on or after 01 January 2024, and that remain outstanding to be listed on the stock exchanges within 3 (three) months of listing the proposed NCDs. Further, it also allows listed entities to list any subsequent issues of unlisted NCDs made prior to and that remain outstanding as on 31 December 2023, on the stock exchanges.  

Key Issues raised by the AIF Industry  

As per the SEBI AIF Regulations, Cat II AIFs are required to invest ‘primarily’, i.e., more than 50% of their investible funds, in unlisted companies as compared to their other investments. As stated in the consultation paper, around 192 Cat II AIFs have more than 50% of their total investment in unlisted debt securities.  

The major concern raised by the AIF industry association is that any entity that has listed its NCDs on or after 01 January 2024, cannot issue any unlisted NCDs, till any listed NCD is existent. Further, the unlisted NCDs are also required to be listed by the investee companies, in case they propose to list any NCD in the future. These LODR Regulations may adversely impact investment avenues available for Cat II AIFs primarily invested in unlisted debt securities, and could also make it difficult for such AIFs to adhere to the condition on primary investment in unlisted debt securities.  

SEBI’s Proposal  

SEBI has acknowledged that the above-mentioned issue may lead to shrinkage of investment opportunities for Cat II AIFs invested primarily in unlisted debt securities. Therefore, it has been proposed that Cat II AIFs should also be allowed to invest in listed debt securities. Further, considering the credit risk for Cat II AIFs, it has been proposed that investment in listed debt securities should be based on a parameter that would ascertain the credit risk. Accordingly, AIFs should be permitted to invest only in listed debt securities having credit rating ‘A’ or below. Accordingly, SEBI has proposed as follows:  

“Category II Alternative Investment Fund to invest more than 50% of their total investible funds in unlisted securities, and/or listed debt securities having credit rating ‘A’ or below, directly or through investment in units of other AIFs.”  

Conclusion 

The proposed amendment to the SEBI AIF Regulations aims to alleviate the challenges faced by Cat II AIFs due to the 2023 amendment to the LODR Regulations, which has limited their access to unlisted debt securities. Further, the proposal to include only listed debt securities rated ‘A’ or below, ensures that Cat II AIFs continue to cater to investors with higher risk appetite. 

The consultation paper can be accessed here, and public comments have been sought on the same by February 28, 2025. 

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