Market regulator Sebi has stirred a hornet's nest by proposing to regulate the fast-growing risk capital industry in India that is slated to invest up to $10 billion this year.

On Monday, Sebi placed a concept paper on its website inviting a debate on its proposal to set up regulations for Alternative Investment Funds, or AIF, that will cover the gamut from venture capital funds to private equity, debt funds, real estate funds and private investment in public enterprises, referred to as PIPE funds, among others.

"The timing is a surprise, we had absolutely no inkling that this would happen," said Satish Mandhana, managing director of IDFC Private Equity, which manages a corpus of nearly $1.3 billion.

While fund managers said that they agree with the need for regulation, in keeping with global precedents, the creation of a new regulatory norm for alternative investments requires greater interface with all sections of government, including the RBI and the tax authorities, if not the AIF will become yet another roadblock.

"There is not enough clarity on taxation norms for domestic funds and the treatment for overseas funds," said Mandhana. Sebi's move is seen as a reaction in part to the growing inflow of risk capital into listed companies in India. In the first six months of this year, PE funds have invested close to $1.3 billion in 27 listed firms compared with $749 million across 40 deals in 2010, according to research firm, Venture Intelligence.

"With substantial capital investments flowing in and given the trend in PE funds investing in PIPE transactions (listed companies in India), some sort of regulations were expected to come in," said Raja Lahiri, partner, transaction advisory services, Grant Thornton.

The Indian regulator is following global precedents such as the tightening of regulations on hedge funds and private-equity funds by the European Parliament.

However, Indian fund managers - already grappling with low returns on risk capital and a mammoth pool of uninvested capital, estimated at $20 billion in a report by consulting firm Bain & Co - are unsure how demarcating between venture capital, private equity and PIPE funds will work in local markets.