The Securities and Exchange Board of India (SEBI) has proposed easing investment restrictions for Category II Alternative Investment Funds (AIFs), permitting them to invest in listed debt securities with a credit rating of ‘A’ or below.

The move follows concerns over a shrinking pool of unlisted debt securities after SEBI’s recent amendments to the Listing Obligations and Disclosure Requirements (LODR) norms.

Under these changes, listed entities are now required to list all non-convertible debt (NCD) securities on stock exchanges, reducing the availability of unlisted debt securities for AIFs.

In its consultation paper, SEBI has suggested allowing Category II AIFs to invest over 50% of their total investible funds in either unlisted securities or listed debt securities rated ‘A’ or below, directly or via units of other AIFs.

Being close-ended funds that primarily invest in unlisted securities, Category II AIFs take on both liquidity and credit risks. They play a crucial role in financing businesses that lack access to traditional funding or are not yet ready for a public offering.

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With the LODR amendments altering market dynamics, SEBI sees merit in expanding the investment scope of these AIFs while ensuring they continue to assume appropriate credit risks. The regulator believes credit ratings serve as a key parameter to assess risk, aligning Category II AIFs with a higher-risk investment strategy.

The proposal follows industry representations highlighting concerns from funds investing predominantly in debt securities. SEBI noted that 192 schemes under Category II AIFs have already allocated over 50% of their investments to unlisted debt.

SEBI has invited public comments on the proposal until 28 February.