Sebi's co-investment proposal gets fund manager backing, but lawyers flag legal gaps, tax risks

Mint

20-05-2025

The market regulator's proposal to allow co-investments within the alternative investment funds (AIF) framework—through a new co-investment vehicle (CIV)—has received broad support from fund managers. But lawyers warn of legal ambiguities, tax risks, and rigid exit conditions that could undermine its effectiveness.
The 9 May proposal by the Securities and Exchange Board of India (Sebi) seeks to replace the current portfolio management services (PMS)-based co-investment route with a more streamlined approach.
Under this, CIVs will have distinct PAN, bank, and demat accounts, and be exempt from some AIF-related rules (such as sponsor commitment and diversification) when co-investing in a single company with the main AIF. Under the current setup, co-investments must route through PMS entities, requiring a separate license, duplicative compliance, and different exit and governance terms—often complicating deal execution and cap table management.
By contrast, CIVs would keep co-investments within the AIF ecosystem, allowing for pooled governance, unified documentation, and faster execution.
Fund managers hailed the move as long overdue. Puneet Sharma, CEO and fund manager at Whitespace Alpha, called it 'a practical and much-needed upgrade."
'It removes a lot of the operational clutter we previously had to deal with through PMS or SPV routes. This setup brings clarity for us as managers and for our investors," he added.
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Exit worries and tax trouble
Despite the optimism, legal experts flag several concerns—starting with investor exits.
'Co-investors coming via CIV could not have an option of remaining invested after the tenure of the AIF ends or exiting earlier," said Vinod Joseph, partner at Economic Law Practice. He also flagged uncertainty around Sebi fees and limitations on fundraising due to the accredited investor restriction.
Ketan Mukhija, senior partner at Burgeon Law, said the legal architecture of CIVs may not hold up well in conflict scenarios.
'The CIV structure legally balances segregation and pooling, but its reliance on contractual terms over statutory safeguards leaves ambiguity in enforcing co-investor rights during disputes."
He warned that tax issues may arise too.
'Tax risks loom if authorities view coordinated CIV-AIF investments as an AOP, stripping pass-through benefits and triggering double taxation", he added.
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Compliance gains, but admin costs stay
While CIVs do reduce regulatory duplication, they come with their own administrative load.
'Each CIV needs a separate PAN, demat, bank account—adding admin burden, especially for decision makers or general partners," said Brijesh Damodaran Nair, managing partner at Auxano Capital.
He added that rigid lock-ins may discourage large co-investors unless some flexibility is introduced.
'GPs must be able to set allocation caps or differentiated economics."
Relaxing advisory rules
The proposal also opens the door for AIF managers to offer advisory services on listed securities—currently prohibited to prevent conflicts of interest.
Sebi is considering relaxing this ban for actively traded stocks but warned of manipulation risks in thinly traded securities.
'This modernizes the framework but raises concerns unless Sebi mandates real-time position disclosures and stricter Chinese walls," said Mukhija.
Sharma supported the move to restrict CIVs to accredited investors, noting it ensures only sophisticated investors participate in high-risk co-investments.
'Over time, as the structure matures, there may be room to revisit and make it more inclusive," said Sharma.
Experts, however, noted that the current accreditation process could use reform.
'They could benefit from simplification," said Divaspati Singh, partner at Khaitan & Co.
'For the proposed co-investment framework to be truly effective and widely adopted, easing or streamlining the accreditation requirements could be a constructive step forward," Singh added.
Sharma also noted that the tax environment is gradually improving.
'Category I and II funds already enjoy pass-through status. CIVs under Category III should benefit from similar treatment if structured right."
Srikanth Subramanian, CEO and co-founder of Ionic Wealth, emphasied CIVs would ease operational burdens by eliminating the need for separate PMS setups.
'This approach also helps prevent conflicts of interest by synchronising timelines and decision-making between the main fund and co-investors," he said. 'It brings Indian AIFs closer to international standards."
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Sebi has invited public feedback on whether CIVs should fully replace PMS-based co-investment structures, and how to address exit flexibility, governance guidelines, and taxation clarity. The deadline for public comments is 30 May.