Implementation Standards for Issuance of Differential Rights by AIFs – An Analysis

Vide its circular dated December 13, 2024 (“SEBI December Circular”), the Securities and Exchange Board of India (“SEBI”) had tasked the standard Setting Forum for AIFs ( “SFA”) with formulating implementation standards (“Implementation Standards”) for issuance of differential rights by Alternative Investment Funds (AIF) for the purposes of the newly introduced Sub-Regulation 22 of Regulation 20 of the Securities and Exchange Board of India (Alternative Investment Funds) Regulations, 2012 (“SEBI AIF Regulations”). Though SEBI had directed the SFA to publish the Implementation Standards on the websites of its constituent industry associations on or before January 15, 2025, the SFA released the Implementation Standards only on January 28, 2025.

The newly inserted sub-regulation 22 of Regulation 20 of the SEBI AIF Regulations stipulates the following guiding principles for the grant of differential rights (“DR”) by AIFs to select investors:

• The investor receiving the DR should not have to bear the liabilities of other investors of the AIF scheme;
• The DR should not give the investor holding the DR the power to make decisions pertaining to the AIF scheme, unless such investor is a member of the AIF’s investment committee;
• Any DR granted by an AIF shall not alter the rights granted by the AIF to its other investors; and
• Full details of the DRs and eligibility to hold DRs shall be transparently disclosed in the PPM of the AIF scheme. Any investor meeting the specified eligibility criteria for a DR may opt to avail such DR.

The Implementation Standards drill down and specify the type and nature of DRs that can be offered by an AIF to its investors with respect to different aspects of such AIF’s commercial terms. For example, with respect to “fund expenses”, DRs may be offered for waiving off or reducing the expenses charged to select investors or for the manner or basis of charging the expenses. With respect to “management fees”, DRs may allow for difference in quantum, manner or basis of charging management fee to select investors.

• The Implementation Standards permit different investors in an AIF to be charged with “fund expenses” on a differential basis. Certain investors may receive a total waiver or may only pay a lesser percentage than other investors. However, the Implementation Standards state that any increase in expenses attributed/attributable to other investors due to such DR offered to select investors, shall be charged to manager/sponsor of the AIF and not to the other investors of the fund. This is meant to ensure compliance with the guiding principle that the investor receiving the DR should not have to bear the liabilities of other investors of the AIF scheme.
• In the case of management fees, the IS states that there can be differentiation between investors in in the quantum of fees and in the manner or basis of charging such management fee. This standard is in line with the industry practice of offering lower management fees to investors who commit higher amounts. It is also common for AIFs to create classes on the basis of the amount of commitment and to charge a lower management fees from classes with higher capital commitments. The aforementioned rationale has also been applied to permit DR in the case of Carried Interest and Hurdle rate of return.
• DRs may be offered to select investors giving them the right to nominate/appoint members on specific committees of the AIF or its schemes. Investors with DRs may also receive preferential terms regarding tenure, remuneration, attendance requirements, information rights, voting rights etc. However, as per Regulation 20(22) of the SEBI AIF Regulations full details of the DRs and eligibility to hold DRs should be transparently disclosed in the PPM. Consequently, it would not be possible to grant DRs that lead to the appointment of investors to select committees. Any such appointment/nomination would have to be based on transparent and objective criteria, such as the quantum of capital commitment by the investor.
• The SEBI AIF Regulations have detailed rules for information, reporting and disclosure to investors. Regulation 22(g) of the SEBI AIF Regulations states that AIFs should, send all their investors a detailed annual report (within 180 days from the end of the financial year) containing financial information of their investee companies and various other details that are spelt out in Regulation 22(g)(B) of the SEBI AIF Regulations. Category III AIFs are required to provide this report on a quarterly basis. Further, the SEBI AIF Regulations have other disclosure requirements that are specific to certain types of funds. For example, Corporate Debt Market Development Funds are mandated to disclose their portfolio to the unitholders on a fortnightly basis and their NAV on a daily basis. In this context, the Implementation Standards allow AIFs to grant DRs to select investors which allow such investors to receive additional information that is outside the scope of the mandate disclosure and/or receive information from the AIF at a higher frequency than the prescribed frequency. Further, the cost of sharing such additional information has to borne either by such select investors or by the investment manager or sponsor of the AIF. The cost of sharing such additional information is not merely the cost of sending the additional information to the investors, but also the cost of procuring such additional information. For example, if a valuer is hired by an AIF to prepare a specific valuation report meant only for holders of a DR, the fees payable to such valuer should be borne either by unitholders who hold the DR and will receive the report or by the investment manager or sponsor of the AIF.
• AIF should bear in mind that the DRs mentioned in the Implementation Standards are exhaustive. This is because the First Proviso to Regulation 20(22) of the SEBI AIF Regulations states that “differential rights may be  offered  to  select  investors  of  a scheme  of  an  AIF,  in  the  manner  as  may  be specified by SEBI, without affecting the interest of other investors of the scheme”.  The Implementation Standards have been prepared by the SFA pursuant to the aforementioned First Proviso to Regulation 20(22) Hence, the DRs mentioned in the Implementation Standards are exhaustive and AIFs should not attempt to give their investors any DR that is not explicitly provided for in the Implementation Standards.

The Implementation Standards can be found here.

We hope you have found this information useful. For any queries/clarifications please write to us at insights@elp-in.com  or write to our authors:

Vinod Joseph, Partner – Email – vinodjoseph@elp-in.com

Paridhi Jain, Associate – Email – paridhijain@elp-in.com