AIFs seek status quo as ‘foreign control’ rules go for a recast

Mumbai: Indian private equity and venture capital funds have forewarned the government and financial regulators that changing the definition of ‘foreign control’ for these local funds could significantly hurt capital inflow.

Commonly called (AIFs), these local fund houses, which have emerged as significant sources of risk capital, made a strong appeal at a meeting about a fortnight ago with senior officials of the (SEBI), Reserve Bank of India () and ministry of finance, two persons familiar with the discussions told ET.

At stake is the future of the fast-growing which has been pooling in money for over a decade from local and offshore investors to bankroll unlisted firms, startups and expanding businesses.

Their concern and the urgent plea requesting a status quo on regulations, stems from the draft FEMA (Foreign Investment) Rules 2026. The draft, released by RBI on July 21, 2026, gives regulators the scope to change the parameters that qualify an AIF as ‘foreign controlled’. Currently, an AIF with almost all offshore investors is regarded as a domestic entity if its sponsor and investment manager are Indian owned and controlled.

As SEBI and RBI had expressed before, such a rule opens the door to regulatory arbitrage: a foreign investor barred from ownership or control in sensitive industries puts money in an AIF (backed by Indian sponsor and manager) to indirectly acquire equity stake in companies operating in sectors having foreign direct investment (FDI) restrictions.

After the draft July guidelines, AIFs fear that a relook at the ‘foreign ownership and control’ definition to curb such indirect ownership would mean that even AIFs with Indian managers and sponsors would be considered as foreign entities if majority of the fund corpus is contributed by foreign investors. Once categorised as foreign entities, such AIFs would run into investment restrictions and formalities applicable to foreign direct investors.

With non-residents accounting for 40% of AIF investments, the draft rules have rattled the industry, as ET had reported on August 11.

“At the meeting, the AIF lobby tried to put across the point that the India story can be best sold by Indian managers. They are best positioned to canvass for capital from various markets — a strategy that has worked in the last 10 years. The industry said that if the government intends to liberalise foreign investments, such a change could slow down inflows,” said a person who attended the meeting.

In fact, AIFs have even asked for a carve out in the existing regulation so that funds whose sponsors and managers are owned and controlled by listed should be treated as domestic AIFs even if more than 50% equity of these institutions is with foreign persons. “Private banks and NBFCs are regulated and registered with RBI. As long as they are listed, AIFs backed by them should be considered domestic. AIFs have asked for simplification of rules related to ultimate beneficial ownership,” said a source.

The regulatory and ministry officials neither raised the issue of regulatory arbitrage nor reacted to the points made by AIF industry officials whose views on the draft norms were sought. The concerns over regulatory arbitrage was first captured in a note placed before SEBI board in May 2024. Besides AIFs’ ‘indirect ownership from downstream investment’, it said, “..there is scope that the investments could flow from our land border sharing countries through AIFs in companies beyond the permissible limit for automatic route under FDI policy, undermining the spirit of Press Note 3 notification and the steps taken by Government of India in this regard.”