Alternative Investment Funds (AIFs) are urging the market regulator to roll back rules requiring investors to be treated strictly on a pro-rata basis, arguing that the framework undermines fee arrangements negotiated by investors, complicates fund operations and could deter large investors critical to private-market fundraising.
Several industry representations have been submitted to the Securities and Exchange Board of India (Sebi) seeking a reversal of the rules introduced nearly two years ago, according to three people familiar with the matter.
“It's an impossible ask because Sebi’s prescription goes against how an AIF works,” said the one of the three people cited, requesting anonymity. “We are actively discussing the matter with the regulator to ensure AIFs do not have to move to a regime which requires irreversible systemic changes in business.”
The dispute centres on Sebi's move to ensure equal treatment of investors within an AIF through what are commonly known as pro-rata regulations. Introduced in 2024 with immediate effect, the rules require investors to participate in investments and receive distributions in proportion to their commitments to a fund.
Following industry feedback, Sebi released a consultation paper in November 2025. But fund managers say the proposal failed to address their core concerns because it continued to link investments and distributions to investor commitments rather than investable capital.
Fee economics
At the heart of the industry's objection is how the rules affect fee arrangements negotiated by large investors.
Historically, investors received returns based on their investable surplus—the capital available for deployment after management fees were deducted. Under Sebi's framework, however, allocations and distributions are tied to committed capital.
Consider an AIF where Investor A commits ₹90 crore and negotiates a 1% annual management fee, while Investor B commits ₹10 crore and pays 2.5%. After one year, Investor A would have contributed ₹89.1 crore and Investor B ₹9.75 crore, giving A roughly 90.2% of the fund's deployable capital.
Under Sebi's proposed framework, however, returns would continue to be allocated according to commitments, giving Investor A 90% and Investor B 10%. Under an investable-surplus model, returns would instead reflect actual capital deployed, resulting in a 90.2% share for Investor A and 9.8% for Investor B.
Fund managers argue that the approach erodes the economic benefit negotiated by larger investors in exchange for sizeable commitments.
“Fund managers have told Sebi that the proposal overlooks the economic realities of private equity and venture capital funds where large investors often negotiate lower management fees in exchange for sizable commitments,” said a second person.
An emailed query to Sebi did not elicit a response.
“If all investors are required to participate on identical drawdown terms and distributions are effectively equalized, larger investors may no longer receive the benefit of the commercial arrangements they negotiated,” said Jinal Gandhi, director-finance and head of investor relations at Alteria Capital.
Drawdown dilemma
Industry executives also argue that the rules reduce flexibility in how capital is called from investors.
A drawdown is the process through which an AIF calls committed capital from investors. Industry executives say the framework effectively requires investors to remain at comparable levels of participation. If Investor A has contributed 25% of its commitment, it becomes difficult for that investor to contribute further unless other investors have reached similar levels. Fund managers argue that this limits their ability to draw additional capital from investors willing and able to fund opportunities more quickly.
“Having differential drawdowns provides flexibility to both fund managers and investors, particularly where larger investors have the capacity and willingness to contribute capital more quickly when opportunities arise. Restricting this flexibility could reduce the attractiveness of AIFs for anchor investors and may ultimately impact capital formation within the industry,” she added.
Unintended effects
The industry says the pro-rata framework is also increasing the use of compensatory contributions, particularly for large investors when new entrants join a fund after initial investments have been made. Such payments compensate existing investors for the time their capital has already been deployed and help prevent new entrants from benefiting from an established portfolio without bearing the same holding period or opportunity cost.
Some investors, however, are reluctant to share profits with older investors.
“Investors do not want to share their profits. This specifically hurts retail investors who usually enter funds at later stages after viewing its performance,” said the third person.
The debate comes as India's AIF industry continues to expand. Total commitments stood at ₹15.75 trillion as of December 2025, according to Sebi data, while funds raised amounted to ₹7 trillion. Category II AIFs accounted for the largest share of commitments at ₹11.64 trillion.
AIFs are classified into three categories. Category I funds invest in sectors considered socially or economically beneficial, including startups, infrastructure and social enterprises. Category II funds include private equity, debt and real-estate vehicles that do not employ leverage beyond operational needs. Category III funds use complex trading strategies and leverage, making them broadly comparable to hedge funds.