Indian private equity and venture capital funds have issued strong warnings to the government and financial regulators about proposed changes to 'foreign control' definitions. According to reports from The Economic Times, these local fund houses, commonly known as alternative investment funds (AIFs), made their appeal at a meeting with senior officials from the Securities and Exchange Board of India (SEBI), Reserve Bank of India (RBI) and ministry of finance approximately two weeks ago. The industry fears that changing these definitions could significantly impact capital inflows into India's economy, with the fast-growing AIF industry having emerged as significant sources of risk capital over the past decade.
The concern centers around the draft FEMA (Foreign Investment) Rules 2026, released by RBI on July 21, 2026. As reported by The Economic Times, these rules give regulators the scope to change 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. However, the draft rules could mean that even AIFs with Indian managers and sponsors would be considered foreign entities if majority of the fund corpus is contributed by foreign investors. This would subject such AIFs to investment restrictions and formalities applicable to foreign direct investors.
The proposed changes have particularly rattled the industry due to non-residents accounting for 40% of AIF investments, according to The Economic Times reports. Industry officials argued that if the government intends to liberalise foreign investments, such changes could slow down inflows. They emphasized that Indian managers are best positioned to attract capital from various markets, a strategy that has worked effectively over the past 10 years. The AIF lobby specifically requested a status quo on existing regulatory definitions to maintain India's attractiveness for foreign investment.
AIFs have requested specific carve-outs in existing regulations, as reported by The Economic Times. They proposed that funds whose sponsors and managers are owned and controlled by listed Indian financial institutions should be treated as domestic AIFs even if more than 50% equity of these institutions is with foreign persons. The industry also asked for simplification of rules related to ultimate beneficial ownership. Private banks and NBFCs regulated and registered with RBI should be considered domestic as long as they remain listed entities. At the meeting, AIF industry officials emphasized that the India story can be best sold by Indian managers who are best positioned to canvass for capital from various markets.
The regulatory concerns over regulatory arbitrage were first captured in a note placed before SEBI board in May 2024, according to The Economic Times. The note highlighted that foreign investors barred from ownership or control in sensitive industries could use AIFs backed by Indian sponsors and managers to indirectly acquire equity stakes in companies operating in sectors with foreign direct investment restrictions. This could potentially undermine the spirit of Press Note 3 notification and steps taken by the Government of India. 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.
