SEBI & RBI's Co-Investment and AIF Rules

The Problem It Solves

Before this reform, an investor who wanted to put additional money into a specific portfolio company — beyond their existing commitment to an AIF — had only one real route: registering as a Co-investment Portfolio Manager (CPMS) under the SEBI (Portfolio Managers) Regulations, 2020. This required a separate registration, added regulatory overhead, and meant each co-investor negotiated and documented their participation individually — often slowing down deal closings and creating cap-table complexity for the investee company.

What Changed

On 8 September 2025, SEBI notified the SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2025, inserting a new Regulation 17A that creates a Co-Investment Scheme (CIV) framework directly within the AIF Regulations. An operational circular followed the next day, on 9 September 2025, spelling out the mechanics. Key features of the new framework:

• Who can launch a CIV: Only Category I and Category II AIFs. Category III AIFs and Angel Funds are explicitly excluded from this route.

• What it enables: A CIV Scheme lets investors in an existing AIF scheme co-invest directly in unlisted securities of a company the parent AIF is already investing in — including in subsequent funding rounds.

• Who can participate: Only accredited investors of the parent AIF are eligible to use the CIV route.

• Deal-specific structure: Each CIV is launched for a single investee company — it cannot be used as a pooled vehicle across multiple deals.

• Co-terminus requirement: A CIV's exit is tied to the exit timeline of the main AIF scheme's investment in that company, preventing co-investors from exiting early in a way that could undermine the primary fund's position.

• The "3x rule": An investor's contribution through the CIV route cannot exceed three times their contribution to the same company through the main AIF scheme — a diversification safeguard. This cap doesn't apply to large institutional investors such as sovereign wealth funds or development financial institutions.

• Filing fee: Launching a CIV Scheme carries a fee of ₹1 lakh (INR 0.10 million).

What It Means for Investors

If you're already invested in a Category I or II AIF and qualify as an accredited investor, this framework gives you a more direct, lower-friction path to increase your exposure to a specific portfolio company you believe in — without needing a separate PMS registration or a parallel legal process. For fund managers, it reduces the operational burden of arranging co-investments outside the fund structure, though the requirement to file a shelf placement memorandum through a merchant banker for each CIV still adds a compliance step.

Why RBI Got Involved

While SEBI regulates AIFs as investment vehicles, RBI regulates the banks and NBFCs that often invest in them — and RBI has long been concerned about a specific risk: regulated lenders using AIF investments to indirectly evergreen stressed loans, effectively refinancing a troubled borrower through a fund structure rather than recognising the loan as a non-performing asset on their own books. This concern first surfaced in RBI's December 2023 advisory, which imposed a strict blanket restriction and required 100% provisioning wherever a regulated entity's AIF investment overlapped with its own debtor exposure.

That 2023 approach was widely seen as blunt — it discouraged legitimate AIF participation by banks and NBFCs across the board. RBI subsequently revisited the framework, issuing a draft circular in May 2025 and finalizing new rules in July 2025.

What Changed: The July 2025 Final Directions

RBI notified the RBI (Investment in AIF) Directions, 2025 on 29 July 2025, repealing the earlier 2023 and 2024 circulars. These Directions apply to commercial banks (including small finance, local area, and regional rural banks), urban and state/central co-operative banks, All-India Financial Institutions, and NBFCs including Housing Finance Companies — collectively termed "Regulated Entities" (REs). The key changes:

• The absolute bar is gone. Previously, a Regulated Entity was completely barred from investing in an AIF that had any downstream investment in a company the RE had lent to. That blanket prohibition has been removed.

• New exposure caps instead: A single Regulated Entity's contribution to any one AIF scheme is now capped at 10% of that scheme's corpus. The aggregate exposure of all Regulated Entities combined to a single AIF scheme is capped at 20%.

• Equity carve-out: Equity and equity-linked instruments (including compulsorily convertible preference shares and debentures) held by the AIF in a debtor company are now excluded from these restrictions — addressing a long-standing industry request, since equity risk is fundamentally different from a debt evergreening concern.

• Targeted provisioning replaces a blanket ban: If an RE contributes more than 5% to an AIF scheme's corpus, and that scheme has downstream (non-equity) investments in a company the RE has also lent to, the RE must make a 100% provision on its proportionate exposure to that specific debtor company — capped at its direct loan/investment exposure to that company. This is far more targeted than the earlier blanket restriction.

• Subordinated units treated conservatively: Where an RE's AIF investment takes the form of subordinated units, the full investment must be deducted from the RE's capital funds, proportionately from Tier-1 and Tier-2 capital.

• Effective date and transition: The new Directions apply from 1 January 2026, or earlier if an RE's internal policy opts in sooner. Investments outstanding as of 29 July 2025, where the RE has fully honoured its commitment, continue to be governed by the older rules. For commitments existing as of 29 July 2025, or new commitments made before 1 January 2026, REs get a choice — follow either the old regulations or the new Directions in full, rather than mixing provisions from both.

What It Means for the AIF Ecosystem

According to RBI-referenced industry data, total commitments to AIFs stood at roughly ₹13.49 trillion as of March 2025, with about ₹5.38 trillion actually invested — so bank and NBFC participation is a meaningful pool of capital for the industry. The shift from an absolute bar to calibrated caps and targeted provisioning is broadly seen as a relief for fund managers who rely on institutional LPs, while still preserving RBI's core objective of preventing regulated lenders from using AIFs as a backdoor to hide stressed exposures. Industry commentary has also noted that the new framework is more closely aligned with SEBI's own due diligence and investment norms, reducing friction between the two regulators' expectations for the same fund.

If you're an individual or family office investor: The SEBI CIV framework is the more directly relevant change — it's a new, more efficient way to deepen your exposure to specific deals within a Category I or II AIF you already back, provided you're an accredited investor.

If you're a fund manager: You now have two live regulatory threads to track — structuring CIVs correctly under Regulation 17A for investor-facing co-investment demand, and understanding how RBI's revised RE exposure caps and provisioning rules may affect your fundraising conversations with bank- and NBFC-backed LPs as the January 2026 effective date approaches.

If you're a bank or NBFC treasury/investment team: The RBI Directions require an active decision — update your internal investment policy, decide whether to opt into the new Directions before 1 January 2026 or continue under the old rules for existing commitments, and reassess provisioning requirements for any AIF exposure that overlaps with your existing debtor relationships.

Together, these changes reflect a broader regulatory pattern in India's AIF ecosystem through 2025–26: SEBI is making it structurally easier for sophisticated, accredited investors to deploy more capital into specific opportunities within a fund they trust, while RBI is replacing blunt, blanket restrictions on regulated lenders with more calibrated, risk-based caps and provisioning. For investors and fund managers alike, the practical takeaway is the same — these frameworks reward those who stay current on compliance deadlines (particularly RBI's 1 January 2026 effective date) and who work with fund managers that have already updated their PPMs, shelf placement memoranda, and investor policies accordingly.