IFSCA issues framework for grant of differential distribution rights to investors

The International Financial Services Centres Authority (Fund Management) Regulations, 2025 (‘FM Regulations’) were amended by the International Financial Services Centres Authority (Fund Management) (Second Amendment) Regulations, 2026 (‘7th Sept Amendments’) with effect from 7 September 2026. Inter alia, Regulation 23(5) and Regulation 35(6) were inserted in the FM Regulations to enable Venture Capital Schemes and Restricted Schemes to grant differential distribution rights to investors.

Until the 7th Sept Amendments came into effect, all investors in a scheme had rights that are pari passu to their contributions in such scheme. Subsequent to the insertion of Regulation 23(5) and Regulation 35(6), Venture Capital schemes and Restricted Schemes can grant differential distribution rights to investors through issuance of senior and junior or subordinate units. Regulation 23(5) and Regulation 35(6) state that ‘the FME has to ensure that any differential distribution rights to investors through issuance of senior and junior or subordinate units in a Venture Capital scheme/Restricted Scheme shall be in accordance with the framework as may be specified by the Authority.’

Pursuant to the 7th Sept Amendments, IFSCA has issued a Circular on 25 September 2026 ('Circular') setting out a framework for the grant of differential distribution rights to investors and issuance of senior and junior or subordinate units. Some of the key features of this framework are as follows:

1.       There can be only one class of senior units. All other classes will be categorised as junior or subordinate units. Senior units allotted to investors cannot differ in terms of risk, priority of returns or loss absorption, though they may differ in fees, currency and other operational aspects.

2.       Investors holding junior or subordinate distribution rights in a scheme may, in any one or a combination of the following:

(a) bear portfolio losses in excess of their pro-rata share;

(b) accept a lower financial return than their pro-rata share;

(c) accept zero financial returns from their investments; or

(d) provide a grant to an ESG Scheme.

3.       Investors (other than accredited investors) who subscribe to junior or subordinate units of a scheme, should invest not less than USD 2 million. Accredited investors who subscribe to junior or subordinate units should invest not less than USD 1 million. There is no minimum investment limit for any grant provided to an ESG Scheme.

4.       The PPM of schemes issuing subordinate units must adequately and prominently disclose the multiple classes of units and the distribution rights attached to them, covering distribution on an ongoing basis, upon redemption and upon winding up. This disclosure must be supplemented with tabular examples illustrating the distribution waterfall under various scenarios, including scenarios involving loss of capital to holders of junior or subordinate classes. The PPM must also disclose the risks arising from such structures, highlighting the additional risks to each class of units.

5.       The FME and its key managerial personnel must undertake due diligence to ensure that:

(a) amounts invested by the scheme in debt instruments are not utilised, directly or indirectly, by the investee company to discharge outstanding debt obligations owed to investors regulated by a financial sector regulator (such as banks, finance companies and insurance companies) or their associates, or to the FME or its associates (this condition does not apply where the contribution from each investor, together with its associates, does not exceed 20% of the scheme's corpus);

(b) the scheme does not facilitate circumvention of any laws, including directions of the Government of India, IFSCA or other financial sector regulators in India; and

(c) the NAV for each class of units is computed by an independent valuer in accordance with the valuation provisions of the FM Regulations, after considering the PPM disclosures and the documented NAV calculation process.

AIFs grant differential distribution rights mainly to attract a wider range of investors, improve fundraising, and enable structures that pure pari-passu or pro-rata models cannot easily support. Junior capital acts as a first-loss or risk-absorbing layer. It improves the risk-return profile for senior investors, making otherwise borderline projects (especially climate, sustainable, or socially oriented ones) more investable.

After the implementation of the 7th Sept Amendments through the Circular, the FM Regulations are now substantially different from SEBI’s regulations for AIFs. Under the SEBI (Alternative Investment Funds) Regulations, 2012 (‘SEBI AIF Regulations’) all investors in a scheme must have rights, pro-rata to their commitment, in each investment made by the scheme and in the distribution of proceeds from that investment (with limited exceptions, such as excused/excluded investors or defaults).[1] Other rights of investors must be pari-passu[2] except in certain specific aspects provided for in implementation standards[3] issued by SFAs, without affecting the interest of other investors. Large Value Funds for Accredited Investors are exempt from the pari-passu requirement (subject to disclosure and undertakings). SEBI permits certain entities such as the investment manager or sponsor of the AIF, Multilateral or bilateral Development Financial Institutions, State Industrial Development Corporations and entities established, owned, or controlled by the Central Government, a State Government, or a foreign government (including Central Banks and Sovereign Wealth Funds), to accept returns lower than, or share losses higher than, their pro-rata share by subscribing to junior/subordinate classes of units.

[The authors are Partner and Associate, respectively, in Corporate and M&A practice at Lakshmikumaran & Sridharan Attorneys]

The 7th Sept Amendments can be found here: International Financial Services Centres Authority

The Circular can be found here: International Financial Services Centres Authority

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[1] Regulation 20(21) of the SEBI AIF Regulations.

[2] Regulation 20(22) of the SEBI AIF Regulations.

[3] https://aifcfo.com/regulatory-updates/5/pdf