The article is co-authored by Muskan, a fifth-year law student at Gujarat National Law University, Gandhinagar, and Lovish Loona, a fourth-year law student at Rajiv Gandhi National University of Law, Punjab.
This post has been divided into two parts. The first part can be accessed here.
Challenges in the Accreditation- Based AIF Regime
Should We Equalise Wealth to the Sophistication?
The assumption for the third Amendment by SEBI that accreditation is synonymous with risk sophistication is deeply flawed and problematic. The criteria predominantly rely on the quantitative indicators, such as income and net worth, while ignoring the qualitative indicators, such as financial and professional experience. Under the AIF Regulation through Regulation 2(ab), an “Accredited Investor” is defined primarily on the basis of financial thresholds, such as a specified level of income, net worth, or investable assets, and the status of accreditation being granted upon satisfaction of all these quantitative-based criteria. This demonstrates that the definition does not require any quality- based criteria to grant the certificate of “Accredited Investor”. In Investor Choice Advocate Network (ICAN) v. SEC, here the ICAN argues that the US Securities and Exchange Commission’s law on criteria for accredited investors arbitrarily uses high net worth and income criteria as proxies for sophistication, excluding 90 per cent of individuals having professional experience from investing in funds, while allowing privileged wealthy people who can satisfy the high net worth criteria. This challenge contends that the law fails to justify why financial thresholds alone would constitute sophistication, and how the investors, after satisfying the criteria, would be able to understand risks better compared to other investors. This complete reliance on the wealth-based eligibility criteria demonstrates SEBI’s assumption that financial capacity is a proxy for financial literacy and risk comprehension. A similar approach was reflected in SEBI’s October 2024 circular, talking about participation in the derivatives market, where the eligibility was determined through monetary thresholds (INR 15 Lakhs) rather than on any financial knowledge or experience. Taken together, these measures highlight that today’s model of accreditation entrenches economic inequality without contributing towards the investor protection.
A comparative perspective from the EU law shows how the criteria for accredited investors can be structured around the actual competence of the investor rather than financial capacity alone. European Law under the Markets in Financial Instruments Directive (“MiFID II”), provides a 3- part test for client seeking “professional” status, where individual has to meet 2 out of 3 criteria, and one of the criteria is quality- based criteria, requires the investor to have a professional position in financial sector for at least one year, thereby showing the quality criteria is involved. The MiFID II framework has adopted a more holistic model compared to India. By requiring a combination of portfolio size, transaction frequency, and professional experience, it creates a multi- dimensional profile of a sophisticated investor. This model reduces the risk of a ‘wealthy but inexperienced’ investor being categorised as professional and thus losing the protections of the retail regime. Adopting a similar two of three criteria for accredited investors in India would allow professionals like Chartered Accountants, Company Secretaries, or even seasoned entrepreneurs without a high personal net worth to be recognised as accredited, based on their demonstrable expertise. If India adopts this framework, it would align the regulatory access with the real world and ensure that the investor autonomy demonstrates understanding rather than economic status.
Dilution of Pari- Passu Right: Structural Concern
AI-only funds have been given an exemption from compliance with pari-passu rights, provided under Regulation 20(22) of the AIF Regulations. Pari Passu Rights means that there should be no discrimination among the investors in a particular scheme and all should be treated equally with regard to exit rights, profit distribution, and other rights. After the amendment, the AI-only fund has been given an exemption, which means that it can offer customised terms and differential rights to selective investors.
While this exemption enhances the flexibility, it also raises some structural concerns. Such as it may lead to some disadvantage, as smaller Accredited Investors lack bargaining power vis-à-vis high net-worth investors, and will be forced to be at a disadvantageous position, even after undertaking the same investment risk as Larger Accredited Investors. This problem undermines the fairness and transparency that the Pari Passu Right seeks to safeguard, even within the sophisticated investor ecosystem.
The solution for this problem can be traced in Article 12 of the Alternative Investment Fund Managers Directive (“AIFMD”) of the EU. Article 12 provided that an investor can get the preferential treatment when it is clearly disclosed in the funds’ foundational documents. It means that every differential treatment of investors should be explicitly mentioned in the fund’s documents. The AIFMD approach of ‘disclosure, not prohibition’ is a practical middle ground. It does not compromise commercial flexibility but mandates that any deviation from the equality rights must be transparent. This allows all the prospective investors to see, ex-ante, the tiered structure of the fund, and make an informed decision about whether the investor wants to invest, given the known advantages that others might have.
Adopting this principle of ‘informed differentiation’ in AI -only funds would help us to preserve autonomy while reinforcing market transparency and investor confidence. This framework, of explicitly mentioning every differential treatment of investors in the fund’s documents, would strike a balance between regulatory flexibility and investor protection.
Removal of Trustee Supervision in AI- only Fund
The third amendment of the AIF Regulations also provided that in the case of an AI-only fund, all the responsibilities and obligations of the Trustee, as per Regulation 20 (24), would be given to the Manager. This would leave the Manager to supervise all the holding, managing and administering the fund property of the AIF trust.
While the exemption is intended to reduce regulatory friction, it also raises some significant concerns from a compliance and oversight perspective. The importance of the Trustee supervision and oversight with the AIF framework is acknowledged by the SEBI itself. In the Adjudication Order of India Asset Growth Fund, SEBI held that both the Trustee and Manager have the responsibility to ensure the compliance of the AIF Fund with rules and regulations. In this case, both Trustee and Manager would penalise for nine breaches by the AIF Fund, which clearly shows that Trustee oversight functions as an independent and enforceable layer rather than a mere requirement.
Given these concerns, the complete removal of trustee oversight in AI- only funds seems difficult to justify. But if the Board is inclined to retain the exemption to AI-only fund, they can have the mandate to have a third party to manage the AIF schemes and the transaction process, aligning with Article 21(1) of the Alternative Investment Manager and amending Directives of the EU. This law mandates the appointment of a single depository by the AIFM, and explicitly prohibits the Manager from acting as the depository under the circumstances. This depository would be entrusted with the core function, including the safekeeping of the AIF’s assets, oversight of cash flows, monitoring compliance with the applicable laws and regulations, and maintaining records relating to the performance of their duties. As an independent entity, it is subject to some defined duties and liabilities, hence serving as a critical check to promote transparency, accountability, and good governance in the management of the AIF.
Adopting a similar framework in AI-only funds, where a third party would serve a check on the activities to ensure transparency and accountability in the AIF. The third party can be a registered intermediary, as may be prescribed by SEBI, which would oversee the fund’s operations. The power to decide the eligibility, nature, and responsibilities of the third-party will lie with the SEBI.
Limited Size of Accredited Investor: Concern to be addressed
The last but not least challenge in implementing Accredited Investor-only Funds is the limited number of accredited investors in India. As of May 29, 2025, there are only 649 accredited investors who are registered with the agencies. The number is very small when we look at the rapidly rising Alternative Investment Market in India. This would substantially narrow the potential fundraising, raising concerns regarding the economic viability, scalability, and sustainability of such funds.
AI- only funds’ success not only depends on regulatory flexibility but also on the availability of sufficient accredited investors. This may lead to capital concentration, repeated reliance on the same investor across multiple funds.
The Consultation Paper dated 17 June 2025 acknowledges this challenge by highlighting the need to broaden the scope of accreditation agencies by including all five KYC Registration Agencies as Accreditation Agencies. One of the proposal of the Consultation Paper was crystallised through SEBI Circular dated 9 January, 2026, which says that if pending application for the accredited investor, based on the Manager’s assessment of the eligibility criteria, the Manager can executed the Contribution Agreement and initiate some related operational procedures subject to some conditions, such as commitment by those investor should not be included and schemes of AIFs cannot receive funds from those investors until they get the certificate. While these developments aim to operationalise the accredited investor-only fund, the core challenge still remains the same until the number of accredited investors increases meaningfully in absolute terms.
Conclusion
The 2025 legal reforms in the AIF Regulation, which move away from “Minimum Commitment Threshold” to “Accreditation” and also introduce Accredited Investor-Only Fund. These reforms aim to provide a ‘lighter touch regulatory framework’ and align Indian Regulations with the global practices by treating the accredited investor as sophisticated investors and assuming that they have a good understanding of investment and can conduct the due diligence by themselves. This shift towards a principles-based regulatory regime is undoubtedly a progressive step for the Indian capital and funds markets. It recognises the maturity of a certain section of the investor base and aims to ease compliance costs; thus, it promotes innovation and attracts investments. The aim to align with international best practices is praiseworthy and reflects the country’s efforts to develop a world-class and top-tier financial system.
However, the reforms always come with their own set of challenges. The reforms proposed by SEBI in the AIF also have some significant challenges. One of the most significant challenges to the success of the Accredited Investor-only Fund is the limited number of accredited investors in India. This makes the potential fundraising remain narrow, raising concerns about capital concentration, scalability and sustainability. While some recent regulatory changes seek to solve the problem to some extent, this problem remains unresolved in substance. The reliance on quantitative criteria of income alone for accredited investors, while ignoring the qualitative criteria, excludes the majority of investors. While the mature jurisdictions like the EU and the USA are moving towards qualitative criteria, we need to take a cue from them in determining sophisticated investors.
Further, the regulatory exemptions granted to AI- only funds, particularly the exemption of Pari Passu rights and the removal of oversight of the trustee, raise serious concerns regarding the fairness, transparency and governance. While flexibility is essential, flexibility at the cost of unregulated asymmetry and weakened supervisory mechanisms may weaken the confidence of investors. Moreover, the limited number of Accredited Investors might aggravate these concerns instead of solving them.Hence, the authors propose balanced solutions for the challenges of these reforms. The authors pitch for qualitative criteria for accredited investors, mandating enhanced disclosures of informed differential treatment, instead of blanket removal of pari passu rights; and independent oversight by third parties, on the basis of a new SEBI proposed model, would strike more balance between the regulatory flexibility and investor protection. In the end, SEBI’s capacity to dynamically adjust these regulations will determine whether India’s accreditation experiment is successful or not. It must therefore progress from a static, wealth-based definition of sophistication to a more nuanced, competency-based definition, to ensure that the real competent investors are not left out of its purview.