SEBI Wants Less Scrutiny of AIF Trustees. Does Its Own Enforcement Record Say Otherwise?

SEBI Wants Less Scrutiny of AIF Trustees. Does Its Own Enforcement Record Say Otherwise?

Summary: In June 2025, SEBI penalised the trustee of a Category II AIF after the fund continued beyond its permissible tenure. The trustee had informed SEBI of the extension, but SEBI found that reporting the violation was not enough: a trustee was expected to act proactively as an independent governance checkpoint. A year later, SEBI’s June 2026 consultation paper proposes widening the AIF conflict-of-interest framework from “associate” to “related party”, while excluding transactions with related parties of the Trustee from the investor-consent requirement. The two positions are not technically contradictory. But read together, they raise a more difficult question: if SEBI expects Trustees to function as active checks on fund governance, should their own conflict ecosystem receive less investor scrutiny?

1. Introduction

In June 2025, SEBI penalised Vistra ITCL (India) Limited, the trustee of India Asset Growth Fund, after the Category II AIF continued beyond the permissible extension of its scheme tenure.^[1] Vistra had informed SEBI about the extension and maintained that investor approval had been obtained. SEBI nevertheless found that the Trustee’s response was not sufficiently proactive, treating the Trustee as an independent checkpoint for compliance and investor protection.^[2] A year later, SEBI’s June 2026 consultation paper on AIF investor consent takes a different approach to another aspect of Trustee oversight. The paper proposes replacing the narrow “associate” test with a broader “related party” framework for conflicted transactions. But it proposes applying that framework to related parties of the Manager and Sponsor, while leaving transactions with related parties of the Trustee outside the investor-consent requirement. SEBI’s stated rationale is that Trustees have a limited role in investment decisions and day-to-day operations.^[3] Is the Trustee an active governance checkpoint whose independence matters to investors, or a sufficiently limited actor whose related-party relationships need less scrutiny?

2. What Does SEBI Expect from an AIF Trustee?

The facts of the Vistra case are important because the criticism was not simply that the Trustee failed to notice a breach. SEBI’s inspection of India Asset Growth Fund covered April 2021 to March 2022. Among other violations, the fund had continued beyond the permissible extension of its scheme tenure. Vistra had communicated the extension to SEBI and relied, among other things, on investor approval for the further extension. SEBI nevertheless found that this did not discharge the Trustee’s responsibilities. It treated the Trustee as a “vigilant overseer” and an initial checkpoint for identifying and preventing regulatory violations. Vistra had treated its role as one of reporting the situation to SEBI rather than taking proactive steps to prevent the breach or ensure that the scheme was wound up when required.^[4]

Vistra itself had not made the investment decision that caused the problem, but the absence of investment-management authority did not eliminate the Trustee’s independent governance responsibility. The consequence was a ₹6 lakh penalty against Vistra (₹3 lakh under Section 15EA and ₹3 lakh under Section 15HB of the SEBI Act).^[5] The order therefore establishes a clear position: SEBI expects an AIF Trustee to do more than observe and report.

3. The Existing Conflict-of-Interest Framework

Under Regulation 2(1)(c) of the AIF Regulations, the definition of “associate” extends to an entity in which a director or trustee, partner, Sponsor or Manager of the AIF — or certain persons connected with the Manager or Sponsor — holds more than 15% of the paid-up equity share capital or partnership interest. The Trustee is expressly included within the existing associate framework. The AIF Regulations further require an AIF to obtain the approval of 75% of investors by value before investing in an associate. Regulation 15 also addresses transactions involving associates and certain AIFs managed or sponsored by the Manager, Sponsor or their associates.^[6] The existing framework has obvious limitations. The 15% threshold can fail to capture relationships that are plainly capable of creating a conflict but do not cross the statutory ownership line.

On June 30, 2026, SEBI released a consultation paper proposing to rationalise the manner in which AIFs obtain investor consent and broaden the scope of conflicted transactions requiring such consent.^[7] One of the paper’s central proposals is to move away from the existing “associate” concept for conflicted transactions and introduce a broader “related party” framework modelled on the Companies Act. The change would potentially capture relationships that the existing 15% threshold misses, including certain relationships arising through common control and connected persons. The more interesting proposal concerns the Trustee. SEBI proposes that the expanded related-party framework should operate principally with respect to the Manager and Sponsor, while transactions involving related parties of the Trustee, AIF Board or designated partners would fall outside the investor-consent requirement. The rationale is that these persons have a limited role in the actual management of investments and day-to-day operations of the AIF.^[8] A Manager decides where the fund invests. A Trustee generally does not. If the purpose of investor consent is principally to police conflicts surrounding investment decisions, there is a coherent case for imposing the heaviest scrutiny on the persons actually making those decisions. But does it completely resolve the governance question?

4. Two Documents, One Regulator

The Vistra order and the 2026 consultation paper concern different regulatory problems. The first asks what a Trustee should do when an AIF is approaching or has crossed a regulatory boundary, while the second asks which relationships should trigger investor consent when an AIF enters into a potentially conflicted transaction. SEBI can therefore reasonably reach different answers without contradicting itself.^[9]

But this difference reveals a tension in how the regulatory framework conceptualises the Trustee. In the Vistra order, the Trustee is not treated as a passive service provider. SEBI describes it as a vigilant overseer and expects it to intervene before a compliance failure becomes irreversible. In the consultation paper, however, the Trustee’s limited involvement in investment management is the reason proposed for excluding its related-party transactions from the investor-consent mechanism.^[10] If the Trustee is sufficiently independent and empowered to be held responsible for preventing violations, should conflicts surrounding the Trustee be treated as entirely irrelevant to investors?

The answer to this question does not have to be “yes, require 75% consent for every Trustee-related transaction.” That would be ignoring the legitimate difference between an investment decision-maker and an oversight body. The better question is whether zero investor-consent scrutiny is the appropriate answer.

5. The Middle Ground

Investor-consent mechanisms are not costless. They create procedural requirements, delay transactions and can become disproportionate where the relevant person has no role in deciding whether the AIF should make an investment. Treating the Trustee in exactly the same way as the Manager or Sponsor could therefore impose compliance costs without necessarily addressing the principal source of investment conflict. Moreover, the Trustee’s independence is itself a regulatory requirement. The AIF Regulations require the Trustee to be independent of the Sponsor and Manager, which provides a structural safeguard distinct from investor consent.^[11] However, the Vistra order demonstrates that SEBI does not regard the Trustee’s limited investment role as meaning that its conduct is of limited consequence. On the contrary, SEBI held a Trustee accountable precisely because it was expected to exercise independent oversight when the Manager’s actions threatened regulatory compliance. That makes the proposed carve-out somewhat difficult to reconcile with a broader investor-protection philosophy.^[12]

Not every Trustee-related transaction is necessarily conflicted, but the existence of a limited investment role does not, by itself, establish the absence of a governance conflict. A Trustee-related entity could still have commercial, financial or institutional relationships capable of affecting how investors perceive the Trustee’s independence. Investors may therefore have an interest in knowing about such relationships even where the Trustee is not the person making the underlying investment decision.

A middle ground needs to be reached. Rather than subjecting all Trustee-related transactions to the same 75% consent requirement applicable to investment-side conflicts, SEBI could consider enhanced disclosure of material Trustee-related transactions, mandatory conflict policies, abstention requirements, or independent review in specified circumstances. Such mechanisms would recognise the distinction between the Trustee and the Manager without treating the Trustee’s conflicts as categorically irrelevant.

6. What This Means for AIF Governance

For now, the June 2026 proposals remain proposals. SEBI invited comments until July 21, 2026, and the subsequent July 2026 amendments to the AIF Regulations dealt with other matters, principally the scheme-filing framework, rather than implementing the conflicted-transaction proposals discussed here.^[13] The immediate lesson for AIF participants is therefore that the regulatory architecture may be moving toward a more differentiated approach to conflicts: greater scrutiny where the conflict affects investment decision-making, and potentially lighter scrutiny where the relevant person performs an oversight role. That approach can work, but only if the distinction between investment management and governance oversight is maintained carefully. If Trustees are expected to intervene proactively when compliance failures arise, their institutional independence remains an important part of investor protection.

7. Conclusion

SEBI’s proposed shift from “associate” to “related party” is a meaningful improvement to the AIF conflict-of-interest framework. The existing 15% threshold can leave genuine relationships outside the regulatory perimeter, and a broader related-party test is capable of addressing that gap. The proposed Trustee carve-out is harder to justify. Limited investment authority should not automatically translate into limited governance scrutiny. The question SEBI’s final framework should answer is not whether Trustees make investment decisions, but whether investors can still rely on the Trustee as an independent check when the Trustee’s own relationships are potentially at issue.

If the answer is yes, some form of visibility into those relationships may be worth preserving.

REFERENCES

^[1] Adjudication Order in the Matter of India Asset Growth Fund, No. Order/AK/JR/2025-26/31478–31483, paras. 15.2.6–15.2.7 (Securities & Exchange Board of India June 20, 2025)

^[2] Id. para 15.2.7.

^[3] SEBI, Consultation Paper on Rationalizing the Requirement of Obtaining Investor Consent at 6–7 (June 30, 2026).

^[4] India Asset Growth Fund, No. 31478–31483, paras. 9.1–9.2, 15.2.6–15.2.7.

^[5] Id. para 22.

^[6] SEBI (Alternative Investment Funds) Regulations, 2012, regs. 2(1)(c), 15.

^[7] SEBI, Consultation Paper on Rationalizing the Requirement of Obtaining Investor Consent, supra note 3, at 3–7.

^[8] Id. at 6–7.

^[9] India Asset Growth Fund, supra note 1, para 15.2.7; SEBI, Consultation Paper on Rationalizing the Requirement of Obtaining Investor Consent, supra note 3, at 6–7.

^[10] India Asset Growth Fund, supra note 1, para 15.2.7; SEBI, Consultation Paper on Rationalizing the Requirement of Obtaining Investor Consent, supra note 3, at 6–7.

^[11] SEBI (Alternative Investment Funds) Regulations, 2012, reg. 4(b).

^[12] India Asset Growth Fund, supra note 1, para 15.2.7.

^[13] SEBI, Consultation Paper on Rationalizing the Requirement of Obtaining Investor Consent (June 30, 2026); SEBI (Alternative Investment Funds) (Second Amendment) Regulations, 2026 (July 14, 2026).