Flexibility in AIF Regulation: SEBI’s New Proposal for Streamlined Exit Processes

Alternative Investment Funds (AIFs) have increasingly become an essential part of India’s investment ecosystem, offering investors diverse opportunities across various sectors. However, as with any investment vehicle, the closure or winding-up process can present significant challenges. Whether due to unresolved legal disputes, pending tax liabilities, or ongoing operational expenses, the exit process for AIFs can often be bogged down by various complications that hinder an efficient closure. Recognising this, the Securities and Exchange Board of India (SEBI) has proposed a set of regulatory changes aimed at addressing these challenges, streamlining the exit process, and offering greater flexibility to AIFs, vide a Consultation Paper dated 5^th February 2026.

In this blog, we will take a deep dive into SEBI’s proposals outlined in its recent consultation paper, which seeks to reduce the compliance burden during winding-up and surrendering AIF registrations, while still maintaining investor protection and operational clarity.

Present Position under the Law Regarding Winding Up of AIFs and Surrender of AIF Registration

Currently, SEBI’s regulatory framework for the winding-up of AIFs is primarily governed by the SEBI (Alternative Investment Funds) Regulations, 2012 (the, “Regulation”). As per Regulation 29(7), once an AIF scheme reaches the end of its tenure, its assets must be liquidated, and the proceeds must be distributed to investors within a year. This process also mandates that all liabilities are settled, and the fund must maintain a “nil” bank balance before the registration can be surrendered to SEBI. However, AIFs often face difficulties when certain liquidated proceeds cannot be distributed due to pending tax disputes, legal proceedings, or operational liabilities. These constraints lead to delays in surrendering registration and completing the winding-up process.

Present Constraint in Winding Up AIFs and Surrendering the AIF Registration

The primary constraint in the current framework is the requirement that all proceeds from the liquidation of assets must be distributed to investors within the “permissible fund life.” The permissible fund life refers to the period within which the fund must liquidate its assets and distribute the proceeds, typically within a year after the scheme’s tenure ends.

However, issues arise when there are outstanding amounts due to ongoing litigation, anticipated tax demands, or remaining operational expenses. AIFs find themselves unable to fully distribute the proceeds and, consequently, cannot meet the regulatory requirement for a “nil” bank balance. As a result, they are unable to surrender their registration and complete the exit process, effectively locking them in regulatory limbo.

This presents a significant challenge for AIFs that are otherwise ready to close but face obstacles in the final stages of the winding-up process.

Suggestion made by SEBI in the CP

The CP suggests key changes to simplify AIF winding-up while ensuring oversight. SEBI proposes allowing AIFs to retain liquidated proceeds beyond the permissible fund life under certain conditions, such as ongoing litigation, tax demands, or operational expenses, subject to specific requirements.

1. Retention of Funds: AIFs can keep proceeds beyond the permissible fund life if they prove ongoing legal or operational issues, with supporting documentation.
2. Investor Consent: AIFs must get approval from at least 75% of investors for retaining funds due to anticipated liabilities.
3. Operational Expenses: Funds must provide invoices or records to justify retained money for operational costs.
4. Inoperative Funds: AIFs no longer managing investments but retaining funds for legal reasons can be classified as “inoperative” with reduced compliance, but still required to submit an annual report on retained funds.
5. Demonstrable evidence of litigation or tax demand: AIFs would need to provide evidence of active legal or tax disputes as a justification for retaining funds.
6. Super-majority consent: For anticipated liabilities, AIFs would need to obtain consent from at least 75% of the investors by value to retain funds beyond the permissible life.
7. Substantiation of operational expenses: Funds can retain a portion of proceeds to cover operational expenses, subject to providing supporting documentation like invoices.

Proposal made by SEBI in the CP

The CP proposes the following measures to help AIFs manage retained funds and ease the exit process:

1. Retention of Funds: AIFs can retain funds beyond the permissible fund life for ongoing or anticipated legal matters, with investor consent and proper justification.
2. Inoperative Fund Status: AIFs no longer managing investments but retaining funds for legal or operational reasons can apply for “inoperative fund” status, reducing compliance burdens and enabling efficient closure.
3. Rationalized Compliance: Inoperative AIFs must submit minimal reports, like an annual status on retained funds, while being exempt from routine filings.
4. Operational Expenses Retention: AIFs can retain funds for operational expenses for up to three years, ensuring only necessary expenses are covered with a clear timeline for closure.
5. Temporary Investments : SEBI has proposed allowing AIF schemes to retain liquidation proceeds beyond the permissible fund life, provided they invest reserves in temporary assets like liquid mutual funds, bank deposits, treasury bills, repo deals, commercial papers, and other high-quality liquid assets as per Regulation 15(f) of the AIF Regulations.

Basically the key proposal includes:

1. permitting AIFs to surrender their registration while retaining funds, with such AIF schemes being designated as inoperative funds, subject to rationalised compliance obligations;
2. permitting retention of funds for anticipated liabilities, subject to the consent of a super-majority of investors; and
3. permitting retention of funds for operational expenses for up to 3 (three) years.

Further in the CP, SEBI has clarified that that for AIFs looking to surrender their registration certificate, but still holding funds because of ongoing legal or tax issues, SEBI proposes to handle these surrender requests by classifying the AIF as an “inoperative fund.” This designation allows the AIF to be officially recognized as no longer actively managing investments, while still retaining some funds for pending issues, and subjecting it to fewer regulatory requirements.

SEBI has proposed to prevent “inoperative funds” from launching new schemes or charging management fees on existing ones. These AIFs can only apply for registration surrender once all liabilities are settled and their account balance is “nil.”

Analysis and Conclusion

SEBI’s consultation paper presents a much-needed reform in the regulatory framework for the winding up and surrender of AIF schemes. By addressing the practical challenges that hinder a smooth exit process, SEBI is creating a more flexible and efficient environment for AIFs. The key proposals, such as the introduction of “inoperative fund” status and the allowance for AIFs to retain liquidated proceeds beyond the permissible fund life, are positive steps towards streamlining the exit process, reducing unnecessary compliance burdens, and ensuring investor protection.

The concept of an “inoperative fund” status is particularly noteworthy, as it offers a solution for AIFs that are no longer actively managing investments but must retain funds due to unresolved legal or operational issues. By reducing the compliance obligations for these funds, SEBI allows them to close more efficiently while still addressing any pending matters. The proposal to permit funds to retain proceeds for ongoing or anticipated legal or tax issues, subject to investor consent, is also a balanced approach, ensuring that decisions are made collectively and with investor approval.

However, there are areas that still require careful consideration. For example, while the retention of funds for anticipated liabilities is allowed, predicting such liabilities can be challenging. SEBI’s framework must ensure that funds do not retain more money than necessary and that investor consent is properly monitored to prevent misuse. Additionally, the three-year limit for retaining operational expenses provides clarity but may pose difficulties for funds with complex portfolios that require more time to cover final expenses.

In conclusion, SEBI’s proposed changes represent a forward-thinking approach that balances flexibility with oversight, addressing the real-world challenges faced by AIFs. By reducing compliance burdens and offering clearer exit pathways, SEBI is fostering a more efficient and investor-friendly environment for AIFs. However, successful implementation will depend on careful monitoring and regulation to ensure that the proposals achieve their objectives without unintended consequences.

Author: Alishan Hossain

Co-Author: Amiya Mukherjee

Disclaimer

This content is intended for informational purposes only and does not constitute a legal opinion. Readers are encouraged to seek legal counsel prior to acting upon any of the information provided herein. Despite our efforts to maintain accuracy, we do not make representations, warranties or undertakings regarding the quality, completeness or reliability of the content.  This content, including the design, text, graphics, their selection and arrangement, is Copyright 2026, Lexplosion Solutions Private Limited or its licensors. ALL RIGHTS RESERVED, and all moral rights are asserted and reserved.

For any clarifications, please reach out to us at 91-33-40618083 or inquiries@lexplosion.in. Refer to our privacy policy by clicking here.