The Reserve Bank of India (RBI) recently rolled out new directives to Regulated Entities (REs), such as banks, non-banking financial companies (NBFCs), and other lenders. These measures are designed to prevent the evergreening of stressed loans, a practice wherein lenders attempt to prolong loan solvency by offering additional loans to the same borrower who is already on the brink of default or in default. The RBI has instructed REs not to invest in any alternative investment fund (AIF) schemes linked to debtor companies.
Understanding the RBI’s Recent Directives
Regulated Entities often make investments in units of AIFs as part of their regular investment operations. The RBI has expressed regulatory concerns regarding some of these transactions. The central bank has specifically highlighted issues arising from replacing direct loans given to borrowers with investments in AIF units by REs, which indirectly links back to the original borrowers.
In light of this, the RBI has explicitly prohibited REs from investing in AIF schemes that include downstream investments in debtor companies related to the RE. If an AIF in which an RE is already an investor makes downstream investments in debtor companies, the RE must liquidate its investment within 30 days according to the directive. Failure to do so would obligate the RE to generate a 100% provision on those investments. Provision in this context refers to the sum allocated or reserved by a company or financial institution to cover anticipated future expenditures or losses.
What Exactly is Alternative Investment Fund?
An Alternative Investment Fund (AIF) refers to a privately pooled investment mechanism, established or formed in India. It collects funds from sophisticated investors, both domestic and international, with the intent of investing according to a specific policy, ultimately benefiting its investors.
These investment tools strictly adhere to the SEBI (Alternative Investment Funds) Regulations, 2012. As of December 2023, there were 1,220 AIFs registered with the Securities and Exchange Board of India (SEBI).
Breaking Down Various Types of AIFs
SEBI has classified AIFs into three main categories. Category I consists of AIFs that invest in start-ups, early-stage ventures, social initiatives, SMEs, infrastructure, or sectors deemed socially and economically beneficial by authorities. These include venture capital, social venture funds, infrastructure funds, and other specified Alternative Investment Funds.
Category II is for AIFs which do not fall under Category I and III and do not undertake leverage or borrowing except to fulfill daily operational requirements. This category includes real estate funds, private equity funds, distressed asset funds, and the like.
Category III AIFs employ diverse or complex trading strategies and may use leverage, including through investment in listed or unlisted derivatives. Hedge funds, PIPE (private investment in public equity) Funds, etc. are registered as Category III AIFs.
In terms of legal form, an AIF can be established as a trust, a company, a limited liability partnership or body corporate. Currently, most AIFs registered with SEBI are in the form of trusts.
