SEBI’s Pre-IPO Placement Ban: Protection, Paradox, and the Path Forward

[Dev and Harshal are students at Gujarat National Law University.]

On 23 October 2025, the Securities and Exchange Board of India (SEBI) issued a clarification to the Association of Mutual Funds in India: mutual fund schemes being barred from participating in pre-IPO placements of equity shares and related instruments. This directive, grounded in Clause 11 of the Seventh Schedule of the SEBI (Mutual Funds) Regulations 1996 (MF Regulations), restricts mutual funds to investing only in the anchor investor portion or the public issue of initial public offerings (IPOs). 

This post examines the rationale behind SEBI’s clarification, presents a critique on its approach, analyses the effect on the competitive positioning of India’s mutual fund industry and recommends less restrictive safeguards.

Regulatory Framework and the Investor Protection Rationale

Pre-IPO placements, as permitted under the SEBI (Issue of Capital and Disclosure Requirements) Regulations 2018, allow companies to sell shares privately to select investors between the filing of the draft red herring prospectus (DRHP) and the completion of listing. These placements, capped at 20% of the fresh issue size, typically occur weeks or even months before the IPO opens to the public.

In contrast, anchor investor allocation happens just one day before the IPO opens for subscription. anchor investors are qualified institutional buyers (QIBs) who can bid for shares up to 60% of the QIB portion, with one-third reserved for domestic mutual funds. The critical distinction lies in timing and pricing: pre-IPO investors often secure shares at discounted rates compared to the eventual IPO price, while anchor investors bid at the final IPO price without any discount advantage.

Clause 11 of the Seventh Schedule of the MF Regulations mandates that mutual funds invest in equity shares and equity-related instruments that are “listed or to be listed” on recognized stock exchanges. SEBI’s 23 October 2025 clarification hinges on the interpretation of “to be listed”— its current stance suggests that securities qualify as “to be listed” only when the anchor portion or public issue opens. This is a narrow interpretation that excludes pre-IPO placements occurring weeks or months before listing. SEBI also highlights that daily liquidity, net asset value (NAV) accuracy, and redemption risk for mutual funds holding unlisted shares present additional technical grounds for this restriction.

SEBI’s primary concern centres on protecting retail investors who invest in mutual funds from exposure to unlisted securities. The regulator warns that if mutual funds participate in pre-IPO placements and the company’s listing is subsequently delayed or abandoned, the fund would be left holding unlisted shares which forms a clear violation of regulatory norms. SEBI’s directive aims to eliminate such regulatory grey areas. By clarifying that mutual funds can only invest in the anchor portion or public issue, both of which occur when the IPO process is already underway, the regulator ensures that mutual funds remain aligned with their mandate to invest in listed or to be listed securities.

The Regulatory Arbitrage and Financial Inclusion Paradox

While SEBI’s investor protection concerns are legitimate, the restriction creates a conspicuous regulatory arbitrage that favors other institutional investors. Alternative investment funds (AIFs), foreign portfolio investors (FPIs), family offices, and high-net-worth individuals (HNIs) can continue participating in pre-IPO placements without restriction. This differential treatment raises fundamental questions about fairness, market efficiency and most critically – financial inclusion.

AIFs, regulated under the SEBI (Alternative Investment Funds) Regulations 2012, are permitted to invest in unlisted securities and operate with a minimum investment threshold of INR 1 crore (excluding accredited investors). FPIs, similarly, face no prohibition on pre-IPO investments. These investors are all regulated entities with sophisticated due diligence capabilities, yet they enjoy access to early-stage IPO opportunities that mutual funds managing over INR 75 lakh crore on behalf of retail investors are now denied.

This restriction creates what can be termed as a “financial inclusion paradox”: SEBI’s move, ostensibly designed to protect retail investors, may actually deepen financial exclusion by creating a two-tier investment ecosystem. Those who can invest INR 1 crore in AIFs, get early access to high-growth opportunities and pricing advantages in pre-IPO placements. Meanwhile, retail investors who pool their savings through mutual funds (with minimum investments as low as INR 500) are locked out of these same opportunities, despite channeling their capital through professionally managed, SEBI-regulated vehicles. It Is worth noting, however, that practical pre-IPO allocations were mostly accessed by large-cap or IPO-focused mutual fund schemes, so the direct impact on small retail-focused funds is limited.

India’s financial inclusion narrative has emphasized democratizing capital markets. The nation’s Financial Inclusion Index stands at 67%, with over 179 million demat accounts opened and mutual fund assets exceeding INR 75 lakh crore. Regulatory initiatives from Jan Dhan Yojana to systematic investment plan promotion have focused on bringing retail investors into formal financial markets. Yet this restriction on pre-IPO participation reinforces wealth stratification in capital market access: only the already-wealthy can access pre-IPO discounts and early-stage public market opportunities, while retail investors are ironically protected out of such opportunities, and miss potential wealth creation avenues.

This creates an uneven playing field. Pre-IPO placements often offer shares at discounts to the eventual IPO price, providing opportunities for alpha generation in the form of returns above market benchmarks. By excluding mutual funds from this space, SEBI may inadvertently disadvantage the very retail investors it seeks to protect, as their pooled investment vehicles lose access to potentially lucrative opportunities available to wealthier, sophisticated investors. This hinders their ability to compete effectively.

The differential treatment also creates a peculiar competitive dynamic. FPIs face no such restriction and can participate freely in pre-IPO placements. This creates a situation where foreign capital has better access to early-stage Indian public market opportunities than domestic retail capital pooled through mutual funds, further undermining efforts to build domestic institutional capacity and disadvantaging homegrown asset managers.

Moreover, this restriction implicitly treats mutual funds as less sophisticated than AIFs or FPIs, despite all being SEBI-regulated entities with professional fund managers, fiduciary duties, and compliance frameworks. This raises questions about regulatory logic: if the concern is investor protection, shouldn’t the focus be on disclosure requirements, concentration limits, and exit clauses rather than blanket prohibition based on vehicle type?

SEBI’s Own Regulatory Sandbox Proposal and the Case for Structured Access

Interestingly, SEBI itself has been exploring a regulated pre-IPO trading platform to replace the grey market, yet it has simultaneously banned mutual funds from participating in this very space. In August 2025, SEBI Chairman Tuhin Kanta Pandey hinted at creating a regulated venue for pre-IPO trading during the 3-day window between allotment and listing. This initiative aims to bring transparency, price discovery, and regulatory oversight to pre-IPO markets, which have historically operated in informal, unregulated channels. He emphasized that such innovation would help address market inefficiencies, yet mutual funds currently remain excluded.

This reveals a regulatory inconsistency worth examining: SEBI recognizes the need to formalize and regulate pre-IPO markets (suggesting their legitimacy and importance), yet bars retail-facing mutual funds from participating in them. If SEBI is willing to create regulated infrastructure for pre-IPO trading, why not allow mutual funds access with appropriate safeguards? The regulator’s own acknowledgment that pre-IPO markets warrant formal structure undermines the rationale for complete prohibition.

It is also pertinent to note that companies that file a DRHP demonstrate a clear intent to list, subject to regulatory approval and market conditions. Therefore, a more ideal safeguard could involve establishing temporal milestones, such as allowing mutual funds to participate in pre-IPO placements only after the company receives SEBI’s observation letter (indicating regulatory clearance). This would significantly reduce the risk of holding indefinitely unlisted shares while preserving some access to pre-IPO opportunities.

Investor advocacy groups have called for a structured, risk-managed regime for mutual fund participation, as seen in other regulated markets. Therefore, rather than blanket prohibition, SEBI could mandate buyback and exit clauses in pre-IPO placements where mutual funds participate. This addresses SEBI’s core concern of funds stuck with unlisted shares if IPOs fail through contractual safeguards. SEBI needs to attempt to be more innovative with investor-protection, while adopting practices which do not restrict their access. 

Additionally, concentration limits and enhanced due diligence requirements could mitigate risk. Mutual funds could be permitted to allocate a small percentage of their assets under management (perhaps 2-3%) to pre-IPO placements, subject to rigorous governance standards, mandatory disclosure to trustees, and quarterly reporting. This would limit exposure while allowing some participation in this market segment. SEBI could also consider allowing select mutual fund schemes subject to risk-tiered investor disclosures and enhanced NAV governance, similar to the onboarding process for AIFs.

Way Forward: Balancing Protection with Opportunity

As India’s IPO market continues its remarkable growth trajectory—poised to exceed USD 20 billion in 2025—the exclusion of mutual funds from pre-IPO placements represents a missed opportunity for broader retail participation in early-stage public offerings and generate alpha returns for retail investors. The challenge for SEBI lies in striking a balance between robust investor protection and enabling mutual funds to compete effectively in India’s dynamic capital markets.

The country has made remarkable strides in democratizing finance—from Jan Dhan accounts to widespread mutual fund participation. Ensuring that wealth creation opportunities in capital markets remain accessible not just to ultra-HNIs (through AIFs) but also to retail investors (through mutual funds) is essential to sustaining this inclusive growth trajectory. The solution should be regulated participation with safeguards, not prohibition that entrenches wealth stratification.

The 2025 amendment marks a significant regulatory moment, but its ultimate impact will depend on whether SEBI can evolve a framework that protects retail investors without locking them out of opportunities. Until such refinements are made, mutual funds will remain on the sidelines of the pre-IPO market, limited to anchor allocations and public issues as India’s IPO boom continues unabated—while the question of whether protection has inadvertently become exclusion remains unresolved.